Bond Trading 1999 - Rich-Cheap & Relative Value

Bond Trading 1999 - Rich-Cheap & Relative Value -...

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1 Rich-Cheap and Relative Value Trading Copyright © 1996-2006 Investment Analytics
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 2 Rich/Cheap Analysis & Relative Value Trading ± Principles of rich/cheap analysis ± Relative value concepts ± Total return analysis
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 3 Rich-Cheap Analysis ± Select the appropriate tax-rate ± Identify the tax-efficient bonds ± Estimate the spot tax-yield curve using the efficient bonds ± Identify the issues which are low yield (‘rich’) or high yield (‘cheap’) relative to the curve ± Initiate duration-weighted trade
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 4 Rich-Cheap Graphical Analysis Cheap Issue Rich Issues Y i e l d Maturity
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 5 Problems with Simple Approach ± Coupon ± Issues with different coupons trade at different yields ± Risk-Return ± Maturity is an inexact measure of risk ± Yield is an inexact measure of return ± Liquidity ± On-the-run vs off-the-run ± Issues on repo special
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 6 Example: Rich/Cheap Analysis Lab ± Simple Example: Worksheet-Rich Cheap Analysis ± Work out spot rates ± Two 2-year notes: ± 71/2% trading at par, 15% trading at 113.69 ± Market Yield ± Calculate YTM on both bonds, given market prices ± Theoretical Price/Yield ± Calculate theoretical price & yield on each note ± Conclusion: ± What is the relationship between coupon and yield?
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 7 Solution: Rich/Cheap Analysis Lab ± 7.5% 2-year Note: Market Theoretical Price Yield Price Yield 100 7.5% 100.09 7.45% ± 15% 2-year Note: Market Theoretical Price Yield Price Yield 113.69 7.5% 113.87 7.41% ± Both issues are cheap, high coupon > low coupon
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 8 Impact of Coupon on Bond Value ± YTM calculation ± Makes simplifying assumption of constant reinvestment rate ± With rising spot rates: ± Low coupon bonds must trade at higher yields than high coupon bonds to compensate
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 9 Iso-Coupon Curves ± Implication ± To judge richness or cheapness of an issue must take account of coupon ± Coupon adjusted yield ± Iso-Coupon Yield Curves ± Group bonds by coupon ± Plot YTM vs Maturity (duration) ± Assess value vs appropriate curve
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 10 Iso-Coupon Curves - Example 5% 6% 7% 0 5 10 15 20 25 30 Maturity Yi el d 0% 5% 10% 15%
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Copyright © 1996-2006 Investment Analytics Rich-Cheap and Relative Value Trading Slide: 11 Bond Stripping & Repackaging ± Trading based on a variant of rich-cheap analysis ±
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This document was uploaded on 11/04/2011 for the course ECON 421 at CUNY York.

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Bond Trading 1999 - Rich-Cheap & Relative Value -...

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