Lecture 2_investments.ppt - Lecture 2 Bond valuation Topics...

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Lecture 2 Lecture 2 Bond valuation Bond valuation
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Topics Topics Overview of the bond market Bond characteristics Why invest in bonds? Bond pricing Bond yields The dynamics of bond prices 2
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Questions we will answer Questions we will answer Among other questions: How does the interest rate affect bond prices with different maturities? What is Yield To Maturity (YTM) and is it a good criteria for investment in bonds? Which bonds are riskier: short or long term bonds? How is the YTM of corporate bonds determined? 3
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The bond market is huge and very important The bond market is huge and very important for the world economy for the world economy The world bond market value was 100 trillion dollars in June 2016: 45% higher than the value of the world stock market! 4
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Bond issuers Bond issuers Governments Companies (corporate bonds) Municipalities Banks and government agencies (e.g. mortgage-backed, other asset backed such as car loans-backed, student loan-backed, corporate debt-backed (securitization). 6
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The bond market The bond market Most investors invest in bonds through insurance companies, pension funds and mutual funds. Considered a safer asset than stocks. 7
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Bond characteristics Bond characteristics Bonds are Fixed income securities They have Face value or par value This is the payment to the bondholders at maturity date A US government bond from 1905 with par value of $1000 8
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Bond characteristics Bond characteristics Zero coupon bonds – treasury bills. Issued with maturities of 1, 3 and 6 months. Coupons – many bonds pay coupons. These are the interest payments to the debtholders. Coupons are paid once a year (in Europe) or once every six months (in the US). Coupon rate: if for example the par value is $1000 and the coupon rate is 10% paid every year then the coupon payment each year is 10%*1000 = $100 9
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Bond characteristics Bond characteristics Floaters: for these kind of bonds the coupon rate varies over time. For example a European bond paying LIBOR+2%. If the LIBOR at the time of payment is 3% and the par value is $1000, then the bond will pay? 5%*1000 = 50 Zero coupon bond. For example Treasury-bills (T- bills) Always sell at a discount. What about coupon bonds? 10
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Bond characteristics Bond characteristics Inverse-floaters. Which is riskier, floaters or inverse floaters? Who issues inverse floaters? Inflation-indexed (TIPS = Treasury Inflation- Protected Securities) 11
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Example: corporate bond Example: corporate bond This is taken from the WSJ. Data is on the Verizon company. Par value $1000 Coupon rate 5.85%, i.e. the bond pays every six months Maturity date 15.9.35 Price 96.025% from the par value, i.e. $960.25. Spread = 157 basis points. This is the difference in YTM between this bond and a T-bond with similar maturity. That is, 1.57% (in annual terms) 100 bp = 1% 25 . 29 1000 2 0585 . 0
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