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Debt Securities make up the fixedincome
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)
. PriceYield 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 priceyield relnship for the bond.
Convexity
is the curvature of the priceyield 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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 Fall '06
 BOGAN,V.

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