Fixed Income Securities Market

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Introduction

● Debt securities / Fixed income securities / Bonds / Debentures

• Characteristics of bonds:
 Par value

 Maturity

 Coupon Rate

 Issue date

 Credit rating – Moody’s, S&P’s, Fitch

 Collateral
● Bond with par value Rs 1000 and coupon rate of 8% might be sold to the buyer for Rs 1000
and maturity is 30 years.

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Types of bonds

● Corporate Bonds
● Convertible Bonds
● Options – Callable and puttable
● Floating rate Bonds
● Zero Coupon Bonds

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Bond Yield

● Yield to Maturity (YTM) is defined as the interest rate (discounting rate) that
makes the present value of the bond equal to price. i.e. YTM is the internal
rate of return on an investment in the bond

● If Bond is issued at discount

● YTM = C+(D/N)
● F+ P
● 2
● If Bond is issued at Premium
● YTM = C-(P/N)
● F+ P
● 2

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Bond Yield

● Current Yield = Annual coupon Payment

● Bond Price

● Yield and Bond Price is Inversely proportional

● Realized compound return

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Bond pricing

● Bond value= Present value of Coupon+ Present Value of Par Value

● Calculate the price for a 8% coupon, 30-year maturity bond with par value
$1000; coupons are paid semi annually. Assume the market rate is 4% per 6-
month period. If the market rate had been 5% per 6-month period calculate the
price of the bond. What if the market rate is 3%?

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Illustration-Bond Pricing

● A coupon bond that pays interest semi-annually has a par value of $1,000, matures in 3years,
and has a yield to maturity of 8%. Find the intrinsic value of the bond today if the coupon rate
is 10%.

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Duration

● Measures the time structure of a bond and bond’s interest rate risk
● Time structure of investment in bonds is expressed in 2 ways
○ State as to how many years an investor has to wait until the bond matures and the principal money is paid back
it is known as its years to maturity
○ The other way to measure is to measure the average time taken for all interest coupons and the principal to be
recovered .This is called Macaulay’s Duration. The concept was introduced by Canadian economist
Frederick Macaulay
● Duration is defined as the weighted average time to maturity, with the weights being present
values of the cash flow in each period

● D= ∑ PvCt x t
● Po

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Illustration

● Two bonds A and B with 7% and 8% coupons having a maturity period of 4 years. The face
value is Rs.1000.Both the bonds currently yield 6%..Calculate Duration
Year Ct PVF @ 6% PvCt PvCt/P0 PvCt x t
P0

1 70 0.943 66.01 0.0638 0.0638

2 70 0.890 62.30 0.0602 0.1204

3 70 0.8396 58.77 0.0568 0.1704

4 1070 0.7921 847.55 0.8191 3.2764

P0= 1034.63 D= 3.6310

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General Rule

● Higher the coupon rate, lower the duration and less volatile the bond
price
● Longer the term to maturity, longer the duration and more volatile the
bond
● Higher YTM, lower the bond duration and bond volatility

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Duration & Price Changes

• Bond prices and yields are inversely related: as yields increase, bond prices
fall; as yields fall, bond prices rise.
• Bond price changes are called bond volatility
• Duration analysis helps to determine the changes in bond price as the YTM
changes. The modified duration determines the changes in a bond's
duration and price for each percentage change in the yield to maturity.

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Modified Duration ( MD)

● Modified duration follows the concept that interest rates and bond prices move in
opposite directions.
● Relative to the Macaulay duration, the modified duration metric is a more precise measure of
price sensitivity. It is primarily applied to bonds.

● A bond's modified duration converts the Macauley duration into an estimate of how much the
bond's price will rise or fall with a 1% change in the yield to maturity. A bond with a long time
to maturity will have larger duration than a short-term bond

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Modified Duration ( MD)

● The modified duration is an adjusted version of the Macaulay duration,

which accounts for changing yield to maturities.
Modified Duration= D/ 1+YTM
n
where:
• YTM=yield to maturity
• n=number of coupon periods per year​
D=Duration

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Illustration

● Bond A
● MD= 3.6310/1+ 0.06
● 1
● = 3.425 %

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Q&A

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