Lecture_Notes_Fixed_Income_Spring_2010

# Lecture_Notes_Fixed_Income_Spring_2010 - 1 An Overview of...

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Unformatted text preview: 1. An Overview of Fixed-Income Securities 1) Why is it important? • Nearly two-thirds of the market value of all the securities that are outstanding in the world are classified as fixed-income securities • Most participants in corporate and financial sectors participate in the fixed-income securities market 2) Definition • Fixed-income securities are financial claims issued by governments (federal and state), government agencies, corporations, banks, and other financial intermediaries. • The cash flows promised to the buyers of fixed-income securities represent contractual obligations of the issuers • When such contractual obligations are not met, the buyers of fixed-income securities will have the right to take control of the firms that issued such debt securities • At the end of maturity, the value of the bond is Min ( cash flow, face value of debt) = F + Min (CF – F, 0) = F – Max(F-CF, 0) F + short on put options on cash flows with exercise price, face value of debt • stocks = Max(CF – F , 0 ) : call option on cash flows with exercise price, face value of debt • A = Max(CF – F , 0) + F exp(-rt) – Max(F-CF, 0) : Modigliani-Miller Theorem I => A is the value of the firm’s cash flows. => Capital structure is orthogonal to the firm value • A – tax rate* Max(CF – F , 0) = Max(CF – F , 0) + F exp(-rt) – Max(F-CF, 0) => Modigliani-Miller Theorem II : All debt financing is optimal 1 3) Classification of Debt Securities • Treasury Securities (43%) : T bill, T note, and T bond • Agency Securities (7 %): Debt securities issued by government agencies, such as the Federal Home Loan Bank (FHLB) and the Tennessee Valley Authority (TVA), Federal National Mortgage Association (FNMA), etc. • Corporate securities (19 %): Issued by corporations. They can be further classified into investment grade and non-investment grade. • Municipals : Issued by state government • Mortgage Backed securities (30 %) : Backed by pools of mortgages. In the event of financial distress, such assets may be sold to satisfy the obligations of debt holders * The statistics is supplied by Lehman Brothers in December 1997 4) Types of Treasury Securities i) Fixed-principal securities :T- bill, T-note, and T-bonds • T- bill : Securities issued by the Treasury with a maturity of less than or equal to one year at the time of issuance are called Treasury bills or T-bills . It does not pay any coupons and may be purchased in auctions at a discount to their face value, which is typically \$ 1 million. Its maturities are 3, 6 , and 12 months. • T- notes : Treasury securities that pay coupons and that have maturities in the range of 1 to 10 years at the time of issuance are called Treasury notes (T-notes) ....
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Lecture_Notes_Fixed_Income_Spring_2010 - 1 An Overview of...

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