midterm review

midterm review - Debt Securities make up the fixedincome...

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Debt Securities make up the fixed-income capital market; promise fixed stream of income or stream determined according to a formula. Cpn bonds obligate issuer to make int pymts, coupon payments , over the life of the bond &then repay the par value (face value)@maturity. Price of any financial instrument = PV of the expected CF’s from the instrument. Determining price requires an estimate of expected CFs & approp req’d yield. Yield (min int rate that investors want), y, on any investment is int rate that satisfies (eq) . Price-Yield Rel: inversely related. Premium bonds: cpn rate > yield. Discount bonds: cpn rate < yield. of a bond is greater , the longer the term to maturity. For a given term to maturity and initial yield, the price volatility of a bond is greater, the lower the cpn rate. Measures of bond price volatility: price value of a bp, yield value of a price change, duration. Duration: approx of ratio of proportional /\ in bond P to absolute /\ in yield. Tangent (gives the rate of absolute price changes) is closely related to the duration (rate of % of price /\ s). Steeper the tangent line-> greater duration. Flatter tangent-> lower duration. For small /\ s in yield, tangent line & duration estimate actual price well. The farther away from initial yield y*, the worse the approximation. Accuracy of the approx depends on curvature (convexity ) of the price-yield relnship for the bond. Convexity is the curvature of the price-yield relnship of a bond. Convexity Measure is the quantification of the sensitivity of the duration of a bond to the changes in interest rates. Graph depiction of the
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