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Class Note 10_S2009

# Class Note 10_S2009 - RSM 330 Investments Class Note 10...

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RSM 330 - Class 11 Summer 2010 1 RSM 330 - Investments Class Note 10 – Bonds August 10, 2020 Maureen Stapleton, CFA

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RSM 330 - Class 11 Summer 2010 2 Information Final Exam Covers all course material Monday, August 16 from 7 to 9 pm in EX 300, 255 McCaul St. Crib sheet – 8.5x11 inches - 2 sides Multiple choice, short answer questions on concepts, problems Checklist posted on Blackboard Two classes remaining – Bonds & bond portfolio management Assignment 2 is due today Project is due Tuesday, August 17 at 4 pm in RT 469 Exam Review Session: August 12 after class???
RSM 330 - Class 11 Summer 2010 3 Plan for today Bonds & the Term Structure of Interest Rates Bond Basics – Yield to maturity, spot rate, forward rate – Slope of the yield curve, coupon stripping Theories of term structure ( ie the shape of the yield curve) – Expectations Hypothesis – Liquidity Premium Hypothesis Readings : Bodie: Sections 13.2-13.3, 14.1-14.5 Optional: “Riding the Bill Curve” and “The Relative Performance of Yield Curve Strategies”

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RSM 330 - Class 11 Summer 2010 4 Calculating the yield to maturity of a bond Review of RSM 230 Example : A 2-year Treasury bond with 9.125% coupon, selling at \$105.18 (The market price is 105.18% of the face value of the bond) – Face value of \$1,000 will be received as principal repayment at maturity Semi-annual cash flows are (0.09125)(1000)/2 = \$45.63 Market price : You pay (1.0518)(1000) = \$1051.80 today Yield to maturity (YTM ), y, is the discount rate that satisfies – The market convention is to quote the Bond Equivalent Yield: BEY = 2 × YTM, which is an approximate annualized version of ( 29 ( 29 ( 29 ( 29 80 . 1051 1 63 . 1045 1 63 . 45 1 63 . 45 1 63 . 45 4 3 2 = + + + + + + + y y y y
RSM 330 - Class 11 Summer 2010 5 Bond price is inversely related to YTM or BEY , ……….but it is positively related to the bond’s coupon rate. Note the following relations between the bond price (P) and the face value (F). If coupon rate = BEY, then P = F. The bond sells at par. – If coupon rate > BEY, then P > F. The bond sells at a premium. – If coupon rate < BEY, then P < F. The bond sells at a discount. In general, YTM is not equal to the average return on the bond . YTM = average return only if the following two conditions hold. 1. The investor holds the bond to maturity. If the investor does not hold the bond to maturity, the return is called the holding period return , which can be very different from the

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RSM 330 - Class 11 Summer 2010 6 The risk structure of interest rates Default or “credit” spreads Consider bonds that have same term to maturity but different credit risks.
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