Fixed Income Securities

Because the returns are not subject to performance

You buy a share of tata steel

You may get a 20% dividend or a 40% dividend or even no dividend

Debt securities are Fixed Income

Bonds with a maturity of 8 years and a principal of 1000

Interest is 8% per annum payable annually
So every year I will get 800
I cannot say your business is booming give me 1000
The issuer cannot say business is dull accept 500

Time value of money

If I tell you I will give you rs 50000 after 3 years or 50000 after 8 years
What matters is not justr how much you get but also when you get it
What is Interest
Interest is Rent for capital

When I give you 50000 I lose the opportunity to use the money
wages are rent for labour
rent is rent for prperty
interest is rent for capital

Nominal and Real Rates of Interest

Invest 100 Rupees and I will give you 108 Rupees after a year
an item that costs 4 Rupees today will cost 4 Rupees after a year
So in money terms 100 Rupees becomes 108
So the return in money terms is 8%
100 Rupees mebase 25 units
108 Rupees means 27 units
So the return in goods terms is 8
The return in money terms is called the Nominal rate of return
The return in terms of goods is called the Real Rate of Return
So in the absence of inflation the nominal rate will be equal to the real rate

Now lets bring in inflation

an item that costs 4 Rupees today will cost 4.25 Rupees after a year
In money terms I am still getting 8%
But in goods terms with 108 rs I can buy only 25.41176
So the real raturn is 1.647059
Inflation is 6.25
So if the inflation rate is 6.25% my real rate of return is only 1.75%
Fisher equation
(1+Nominal Rate) = (1 + Real Rate) x (1 + Inflation)
(1+Real Rate) = (1+Nominal Rate)/(1+Inflation0 Nominal Ra 0.08
1.016471 Real Rate 0.0625

We have a money bond and a goods bond

Today's price of a good is P0 and next year's price will be P1
p1 and p0 need not be equal - we are allowing for inflation
But we assume that P1 is known today itself
There may be inflation but it is known with certainty
Money Bond - Invest 1 Rupee you will get 1 + R rupees
Goods Bond - invest 1 item of the good you willget 1+r items of the good after one year

If I invest 1 Rupee in the money bond I will get (1+R) Rupees

With this I can buy (1+R)/P1 units of the bond

If I invest 1 Rupee in the goods bond I will get 1/P0 units of the good
which will become (1+r)/P0 units after a year
If both bonds have to be in demand I must get the same number of units of the good in both cases
(1+R)/P1 = (1+r)/P0
(1+R) = (1+r)x(P1/P0)
How do we define inflation
(P1-P0)/P0 is the rate of inflation let us call it pi
p1/p0 = 1+ pi
(1+R) =(1+r)x(1+pi)
1 + nominal rate = 1 + real rate x 1+ inflation rate
The inflation and real returns can be ex-ante or ex-post
Ex-antde means before the event it is a forecasted or anticipated value
Ex-post means after the event IT is a realized value
I want a nominal return of 8.4% Assume there is no risk 0.084
My ex-ante inflation expectation is 4% 1.084
So what is my ex-ante real rate
Suppose actual inflation is 6.2% what is my ex-post real rate 0.062
Suppose actual inflation is 9.6% what is my expost real rate 1.062
1.020716

0.042308 The expost real rate can be different from the ex-ante real rate
0.020716 The expost real rate can be negative
-0.010949 The exante nominal rate is usallhy not negative
In some ecomonies banks have started quoting negative rates of interest
However if inflation is very high then the ex-post real rate may be negative
as an investor you are worse off
I invest 100000 Rupees in an FD paying 8.4%
I hope to buy 20000 units after a year
I think the price 5.42
The actual price is 9.24
If I get 108400 Rupees
11731.6
Inflation is called the Silent Killer
1+ Real Rate = 1+nominal/1+ inflation'
Nominal Returns are used in another sense also

ICICI Bank They will pay 8.4% per annum compounded annually

HDFC Bank They will pay 8.24% per annum compounded quarterly
You want to invest 100000 for 1 year

8.24% per annum means 2.06 per quarter

1 rs 1.084981
In the case of ICICI the quoted rate aka nominal rate is 8.4%
The effective rate of interest is also 8.4%
because interest is compounded only once a year
In the case of HDFC the nominal rate is 8.24%
But the effective annual rate (EAR) is 8.5%
What is EAR
It is that annual rate, which if paid once a year has the same implications
paying 8.5% annually is equivalent to payimg 8.24% quarterly
So when compounding frequencies are different
decisions should be based on Effective Annual Rates and Not Nominal Rates EAR Formu(1+i/n)^n-1

Bank says 8.72% per annum compounded monthly 8.72 compounded monthly what is the E
what is the EAR 0.090771
0.09077090644
Suppose I say 8.72% compouned monthly Suppose I want 9.36% per annum effecti
monthly rate is 0.0072666666666667 How much should I quote with monthly
One Rupee 1.0072667 after one month 0.089809
after 2 monthts 1.01458613777778 8.981% per annum with monthly compo
after 3 months 1.02195879704563
after 12 months 1.09077090643582 0.089809
So paying 8.72% per annum with monthlhy compounding is equivalent
to paying 9.077% once at the end of the year So use the effect function to find effecti
and the nominal function to find nomin

Principle of equivalency
It says two nominal rates compounded at different freqiuencies are equivalent if they give the same effective annual rate

Bank-A 8.4% with quarterly compounding 8.4% with quarterly compounding how
Bank-B says x% with monthly compounding 0.083419
If the two rates are equivalentg what is the value of x
Do it manually and then using a combination of Effect and Nominal functions
8.4% with quarterly compounding is equivalent to 8.342% with monthly compounding
Using Nominal and Effect functions get the same result
Let is convert 8.4 with quarterly compounding to EAR
0.08668323848
0.08341876542

Simple Interest and Compound Interest

Simple Interest: Every period interest is paid only on the original principal
No interest is payable on any interest accumulated during the investment
So every period the interest earned is a constant
I invest 10000 Rupees at 8% per annum for 3 years
After 1 year 10800 Interest for the first year = 800
After two years 11600 Interest for the second year = 800
After three years 12400 Interest for the third year = 800
So if I invest P Rupees at a rate of r per annum for N years
P(1+rN)

Compound Interest says that interest is payable on any interest accrued until then
First year 10000 will become 10800 First year 800
second 11664 Second 864
third 12597.12 Third 933.12
The interest steadily increaseds

If you invest for one period there is no difference between simple and compound techniques
But if you invest for multiple periods then compound interest gives greater return s
If you invest for less than a period simple interest is better

I will pay 8.4% interest compounded annually I will give something after 6 months
and you want toi invest for 6 months that will effectively become 1.084 after
show that simple interest will give you more than compound interest

If I get simple interest for 6 months 1.042 1.085764

If I get compound interest for six months 1.041153207
So if the investment is for one period then you arr indifferent
If it is for multiple period then compound interest is better
If it is for less than a period then simple interest is better Compounding once a year
if invest for less than a year then simple
If compounding quarterly
then if I invest for less than 3 months sim
Compounding monthly
if I invest for less than a month simple in

jesus was born 2022 years ago

Somebody invested 1 Rupee at that time and it has earned 1% interest per annum Fixed Income Securities: Con
How much will you have today Sunil Kumar Parameswaran

546786506.396 547 million Bond markets: Analyses and

by Frank fabozzi (Indian editi
East India coompany came in 1750 Fixed Income Markets by Sur
Somebody invested 100 Rupee at 3% per annum (Indian Indian Available)
310259.522532
I will give detauled PPts
and excel filed after every cla
 2.06
0.0206

i= interest
n= number of compunding periods
(1+i/n)^n-1

pounded monthly what is the EAR

want 9.36% per annum effectively

h should I quote with monthly compounding

er annum with monthly compounding is equivalent to 9.36% with annual compounding

e effect function to find effective rates

ominal function to find nominal rates

ame effective annual rate

quarterly compounding how much is the EAR 0.086683

0.083419 Nominal Rate Formul (((1+EAR)^no.of compunding period)-1)*no. of compounding periods)

0.086683
 something after 6 months
ffectively become 1.084 after one year

ding once a year

or less than a year then simple interest is better
unding quarterly
nvest for less than 3 months simple interest is better
ding monthly
for less than a month simple interest is better

Fixed Income Securities: Concepts and Applications

Sunil Kumar Parameswaran

Bond markets: Analyses and Trading Strategies

by Frank fabozzi (Indian edition available0
Fixed Income Markets by Suresh Sundaresan
(Indian Indian Available)

I will give detauled PPts

and excel filed after every class
ounding periods)