Lecture05 Fixed Income Securities

Lecture05 Fixed Income Securities - Fixed Income Securities...

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Unformatted text preview: Fixed Income Securities Tyler R. Henry 1 FINA 4310 Outline Contents 1 Bond Basics 1 1.1 Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2 Yields . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.3 Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2 Interest Rate Risk 7 2.1 Maturity effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.2 Coupon Rate Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3 Duration 9 3.1 Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3.2 Price changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.3 Convexity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 4 14 1 Bond Basics Bond Terminology Coupon payment Typically semi-annual Coupon rate Annual coupon dollar amount divided by par value Par value (face value) usually $1,000 1 Price reflects current market rates Yield current interest rate determines yield and therefore the price Maturity Timing of Cash Flows Consider a coupon bond with a 9% coupon rate, $1,000 par value that matures in 5 years. Draw the time line of the bonds cash flows with: 1. Annual coupon payments Timing of Cash Flows Consider a coupon bond with a 9% coupon rate, $1000 par value that matures in 5 years. Draw the time line of the bonds cash flows with: 1. Annual coupon payments 2. Semiannual coupon payments 2. Semiannual coupon payments Timing of Cash Flows Consider a coupon bond with a 9% coupon rate, $1000 par value that matures in 5 years. Draw the time line of the bonds cash flows with: 1. Annual coupon payments 2. Semiannual coupon payments 1.1 Pricing Bond Pricing Bond Price = PV of Coupon Payments + PV of Par Value P B = T X t =1 C (1 + r ) t + Par V alue (1 + r ) T P B = C 1 r 1- 1 (1 + r ) T | {z } Annuity CF stream + Par V alue (1 + r ) T | {z } Lump sum CF P B = bond price C = coupon payment r = periodic discount rate T = number of periods to maturity 2 Bond Pricing Example : Consider a bond with 10 years until maturity, a $1000 face value, and a 9% coupon rate. The yield to maturity on this bond is 10% (annual). 1. What is the price of this bond if it makes annual coupon payments? 2. What is the price of this bond if it makes semiannual coupon payments? 3. What happens to the price of the bond if the interest rate (YTM) is instead 9% (assume semiannual payments)? What does this imply about the relationship between between interest rates and bond prices? Bond prices, yields, and maturities Bond prices, yields and maturities Coupon rate YTM Maturity Price 9% 8% 5 $1,041 9% 9% 5 $1,000 9% 10% 5 $961 9% 8% 30 $1,113 9% 9% 30 $1,000 9% 10% 30 $905 $0 $500 $1,000 $1,500 $2,000 $2,500 $3,000 $3,500 0% 5% 10% 15% 20% YTM Bond Price 30 year 5 year Bond prices, yields and maturities...
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This note was uploaded on 06/06/2011 for the course FINA 4310 taught by Professor Staff during the Spring '08 term at University of Georgia Athens.

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Lecture05 Fixed Income Securities - Fixed Income Securities...

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