Lecture 3 - Lecture3:Announcements Assignment1...

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Lecture 3: Announcements • Assignment 1  – Now available on web – Due in class on Thu July 15 th – Solutions posted online on Friday July 16 th • Extra readings: JPMorgan research – Available on web – Optional: For your own information only Global Data Watch  ( JPMorgan View  inside) US Fixed Income Markets Global Fixed Income Markets When will Fed hike interest rates?
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Lecture 2: Recap • Topic 1 continued:  – AER and APR – Inflation: nominal vs. real cash flows and interest rates – Consistent discounting approach: • Real with real • Nominal with nominal • Topic 2: Investment decision rules – Net Present Value (NPV) – Opportunity cost / cost of capital – Internal Rate of Return (IRR)
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Lecture 3: Outline • Topic 3: Bond pricing (Chapter 8) – Yield to Maturity (YTM) – Bond prices over time – (Annualized) holding period return – YTM and realized yield – Term structure of interest rates Discount factors / bootstrapping the yield curve – Short-selling – Arbitrage Locking in forward rates + arbitrage example Understanding the shape of the yield curve
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Topic 3: Fixed income securities (Ch 8) Promises to pay fixed coupon amounts at pre-specified dates and a fixed principal amount at the maturity date Failure to make payments represents a default In reality can be much more complicated Coupon payments can be linked to various factors Ex: floating rate bond, TIPS, etc… Principal can be repaid earlier: Callable/puttable bonds Hybrids: Convertible bonds Market size – Global government bonds   $15tr – Global corporate bonds   $5tr (2/3 in US)
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Bond cash flows Coupon bond (note: last payment is face  + coupon ) Zero coupon bond -100 -50 0 50 100 150 0 1 2 3 4 5 time cash flow -100 -50 0 50 100 150 0 1 2 3 4 5 time                           C              C              C              C             C+F
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Coupon bonds Annual coupon payments are typically stated as a percentage of the principal (or face value ) If coupon payments are made m times per year, then each coupon amount is (c∙F)/m , where c is the coupon rate and F is the face value U.S. Treasury Notes and Bonds typically pay semi- annual coupons German and most European bonds: annual coupons Example: What payments do you receive if you buy a 30 year bond with face value $10,000 and coupon rate of 8% (paid semi-annual)?
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Terminology Government issued debt: Less than 1 year maturity: bills 1 to 10 year maturity: notes Over 10 year maturity: bonds Money market instruments : sub 12 month maturity Issued by government: bills Issued by corporate: commercial paper
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Terminology (2) Domestic (sovereign) debt : debt issued by government in local currency
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Lecture 3 - Lecture3:Announcements Assignment1...

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