Topic 4. The Bond Markets.pptx

Topic 4. The Bond Markets.pptx - BX2031 The bond markets...

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The bond markets BX2031  Personal portfolio Management
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Overview of Sessions 1 - Pricing a coupon-paying bond 2 - Duration and convexity 3 - Indexed bonds & Asset-backed securities Required reading: Chapter 6 Brailsford et al. (2015) 5 th ed. Self study questions: 6.4; 6.10; 6.12; 6.28
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Pricing a coupon-paying bond BX2031  Personal portfolio Management
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Pricing a coupon-paying bond Coupon bonds are generally issued with terms greater than 12 months. Examples include: Commonwealth government bonds semi-government bonds corporate long term securities (e.g. debentures). The coupons can be viewed as a series of zero-coupon bonds: one for each of the coupon payments and one at maturity.
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Pricing a coupon-paying bond Price of a coupon-paying bond is: where c(t) is the coupon payment in period t y(t) is the yield at time (t) FV is the face value paid at maturity (T). The price of a coupon-paying bond can also be expressed as an annuity: where c is the coupon payment in period t y is the yield FV is the face value (principle) paid at maturity (T).
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Pricing a coupon-paying bond Example Given a yield of 3.6% p.a. on a 2-year 4.5% p.a. bond with principal of $100 000, price can be calculated as: The price of a coupon paying bond can exceed the face value of the bond (i.e bond is selling at a premium to FV). Consider a bond with a coupon rate of 4.5% p.a., term of 2yrs and a face value of $100. If y = 3.6% p.a., P = $101.722 per $100. (i.e. trades at a premium to FV) If y = 5% p.a., P = $99.060 per $100. (i.e. trades at a discount to FV)
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Pricing a coupon-paying bond Where the coupon rate is less than the yield, the bond price is less than the principle, and vice versa. To summarise: Premium: c > y implies P > FV (i.e. coupon rate is greater than market yield) Par: c = y implies P = FV (i.e. coupon rate is equal to market yield) Discount: c < y implies P < FV. (i.e. coupon rate is less than market yield)
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Duration and convexity BX2031  Personal portfolio Management
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Duration and convexity
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