Chapter 6 - Chapter 6 Yield Measures Spot Rates and Forward...

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Chapter 6 – Yield Measures, Spot Rates and Forward Rates 1. Sources of return from investing in a bond 1. Coupon interest payments 2. Capital gain or loss: when a security is sold, matures or called 3. Income from reinvestment of cash flows 2. Computation of traditional yield measures: 1. Current yield = annual dollar coupon interest/price 1. Current yield = $7/$94.17 = 7.43% (coupon=7% and bond price = $94.17) 2. Yield to maturity: is the interest rate that will make the PV of a bond’s cash flow equal to its market price + accrued interest. 1. Practice: determine the ytm of a 6% 15yr bond selling for $84.25 (is it 7.2%, 7.6% or 7.8%) 2. Relationship between price, coupon rate, current yield and ytm 1. Par: cr = cy = ytm 2. Discount: cr < cy < ytm 3. Premium: cr > cy > ytm 3. Cash flow yield: For an assumed prepayment rate speed, cash flows can be calculated for an ABS or an MBS. Cash flow yield is the interest rate that will make PV of a bond’s cash flow equal to its market price + accrued interest. 1. (limitations of this type is the uncertainty in the nature of the cash flows for MBS and ABS) 4.
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