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Types of Bonds
Government Securities Corporate Bonds Callable Bonds Puttable Bonds Convertible Bonds Floating Rate Bonds Preferred Stock Foreign Bonds Eurobonds Indexed Bonds
Compensation Bond Converted Stock Floating Rate Bond Govt. Loan Partly Paid-up Loan Treasury Bill Zero Coupon Bond Index Bond
GD GC GF GS GP TB GZ GI
Public Sector Unit
Promissory Note Taxable Bond Tax-Free Bond Zero Coupon Bond Cumulative Bond Infrastructure bonds
PD PT PF PZ PE PI
Floating Rate Bond Non-SLR Bond SLR Bond Zero Coupon Bond Deep Discount Bond Tax free bond
FB ID IB IZ DI IF
Bonds Certificate of Deposit Floating Rate Bond Zero Coupon Bonds
BB CD BF BZ
Commercial Paper Debentures Promissory Note Deep Discount Debentures Floating Rate Debenture Infrastructure Bonds
CP DB CN DC CF CI
Mutual Funds Unit 64 Mutual Fund Units Cumulative US MF MC SPV Securitised Debt SD Local Bodies Municipal Taxable Bonds Municipal Tax Free Bonds Statutory Corporations Taxable Bonds Statutory Corporations Tax-Free Bonds MT LF TS SF .
Yield on Bonds .
Issues in Bond Pricing Accrued Interest Held till Maturity Date Bond Pricing Between Coupon Dates Yield to Maturity Yield to Call Realized Yield Bond Prices Over Time Zero Coupon Bonds Yield to Maturity Vs. Holding Period Returns .
100 14% Rs.Consider two bonds A and B. 100 Term to Maturity Coupon Payments 4 Years Annually 7 Years Annually . they have the following characteristics: Bond A Face Value Coupon Rate Current Market Price Rs. 100 Bond B Rs. 100 14% Rs.
104. 97.42%) What did you notice regarding the percentage price change in case of bonds A and B identical in all respects except term to maturity? If the interest rates increase by 1%. 95. (14% in both cases) If the interest rates fall by 1%. what will be the current price of Bond A and B? (Bond A Rs.Compute the YTM of Bonds A and B.17 and Bond B Rs. 102.84) What do you observe when the interest rate increase by 1% and fall by same amount in both the bonds? . (Bond A Rs.94 and Bond B Rs.94% and Bond B 4. what would be the new market price of the bonds.42) What is the percentage change in the price of two bonds? (Bond A 2.
they have the following characteristics: Bond A Face Value Coupon Rate Term to Maturity Coupon Payments Rs.Consider two bonds A and B. 500 12 % 3 Years Annually . 500 8% 3 Years Annually Bond B Rs.
457.98) If the YTM of both Bonds increase by 15%. what will be the market value? (Bond a Rs.Compute the current market price of bonds A and B (It will be equal to the face vale of the bond in both cases) If the YTM of Bond A and B are 10% and 15% respectively.15) What do you observe in case of price changes for a change in the YTM by same rate? . 465.62 and Bond B Rs. what will be the market price of the bond A and B? (Bond A Rs.98 and Bond B Rs. 474. 398.
500 Term to Maturity Coupon Payments 3 Years 5 Years Semi Annually . they have the following characteristics: Bond A Face Value Coupon Rate Current Market Price Rs.Consider two bonds A and B. 500 12% Rs. 500 12% Rs. 500 Bond B Rs.
73 and Bond B Rs. 487.If the interest rates increase by 1%. 482) What do you observe regarding the percentage price change in these bonds as the term to maturity increases? . what are the market values of these bonds? (Bond A Rs.
Types of Yield Curve .
Features of Duration .
Modified Duration and Price Volatility .
Bond Convexity .
Relationship between Factors and Convexity .
thus leaving the value of the pension fund's surplus or firm's equity unchanged. including cash flow matching. duration matching and volatility and convexity matching. immunization can be used to ensure that the value of a pension fund's or a firm's assets will increase or decrease in exactly the opposite amount of their liabilities. If the immunization is incomplete. or options. these strategies are usually called hedging. these strategies are usually called arbitrage. Interest rate immunization can be accomplished by several methods. Similarly. regardless of changes in the interest rate. futures. It can also be accomplished by trading in bond forwards. If the immunization is complete. interest rate immunization is a strategy that ensures that a change in interest rates will not affect the value of a portfolio. . In finance.
the firm's expected cash inflows would exactly match its expected cash outflows. Nevertheless.Cash Flow Matching Conceptually. . if a financial company is obliged to pay 100 dollars to someone in 10 years. Thus. a firm with many expected cash flows can find that cash flow matching is difficult or expensive to achieve in practice. For example. the easiest form of immunization is cash flow matching. it can protect itself by buying and holding a 10-year. and a change in interest rates would not affect the firm's ability to pay its obligations. zero-coupon bond that matures in 10 years and has a redemption value of $100.
To make the match more profitable. . the first derivative of the asset's price function with respect to the interest rate. the second derivative of the assets is set to exceed the second derivative of the liabilities. the duration of the assets is matched with the duration of the liabilities. Here. the assets and liabilities are arranged so that the convexities of the assets exceed the convexity of the liabilities.Volatility Matching A more practical alternative immunization method is duration matching. is matched with the liabilities. Alternatively. alternatively.
an immunized portfolio can be created by creating long positions with durations at the long and short end of the curve. Government Treasury yield curve reveals that more than 90% of the yield curve shifts are parallel shifts.S. These positions protect against parallel shifts and slope changes. by creating long and short positions along the yield curve. . It is usually possible to immunize a portfolio against the most prevalent risk factors. Using that knowledge.Immunization in Practice Immunization can be done in a portfolio of a single asset type. such as government bonds. followed by a smaller percentage of slope shifts and a very small percentage of curvature shifts. A principal component analysis of changes along the U. and a matching short position with a duration in the middle of the curve. in exchange for exposure to curvature changes.
individual investors infrequently have the resources to properly immunize their portfolios. the issuer of a bond). Users of this technique include banks. pension funds and bond brokers.Difficulties in Immunization Immunization. insurance companies. can protect against term mismatch but not against other kinds of financial risk such as default by the borrower (i. which is rarely the case. if possible and complete. The disadvantage associated with duration matching is that it assumes the durations of assets and liabilities remain unchanged. ..e.
Theories of Interest Rates .
Pure Expectation Theory .
Law of One Price no transaction cost is involved in arbitrage activity there is no restriction on short sales securities are perfectly divisible arbitrageurs can borrow and lend at the same rate information is simultaneously available to all market participants arbitrageurs are able to invest in the securities in the same proportion in which these comprise the stock index .
(1+fn)] Where: rn = current spot price or YTM on a n year bond fn = expected spot rate prevailing at the end of the year µt¶ t = time period n = forward rate for the nth year ..(1+ rn)n = [(1+r1) (1+f2) «««.
The spot rate on a one year. Find the forward rates for second and third year. 9.502% and 13.559% .00% and 10. two year and three year Govt.5%. securities are 8. 9.50% respectively.
What is the implied yield for 1 year bonds starting 3 years from now? 10.Assume that 4 year bonds are currently yielding 7% and 3 year bonds are yielding 6%.06% .
26% and f4= 13. f3= 11.00 f2= 10.The following yields exist on government bonds.28% .75 10.25 11. You are required to calculate the forward rate for the fourth year according to the expectation theory.50%.00 9. Maturity Period (in Years) 1 2 3 4 YTM (%) 9.
5%.56% . 17. what would be the implied average forward rate for a 3 year bond starting in 7th year.If the YTM of a 6 year bond is 13% and that on 9 year bond is 14.
The YTM of a 10 year bond is 15% and a similar 5 year bond is yielding 10%. what would be the forward rate on a five year bond starting in sixth year? 20.22% .
Calculate the forward rate. bond A matures at the end of one year and bond B matures at the end of two years.A bond trader has two zero coupon bonds whose face values are Rs. The current market price of these two bonds are Rs. 445 respectively. Forward rate 6. 475 and Rs.742% . 500.
Liquidity Preference Theory .
Segmentation Theory .
Loanable Fund Theory .
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