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Unformatted text preview: FixedIncome Securities (cont’d) Professor Ruslan Goyenko Fall 2010 Investment Manageme nt, Lecture 13 2 Example: YTM on a SemiAnnualPay Coupon Bond • Suppose that a 4year bond has a face value of 1000 and pays semiannual coupons of 40. • If the YTM is 10% ▫ what is the price? ▫ what is the effective annual rate? • If the price is 1000 then what is the YTM? • If the price is 1070 then what is the YTM? • How are the price and YTM related? Fall 2010 Investment Manageme nt, Lecture 13 3 Realized Compound Yield vs. YTM Ø Consider a threeyear bond selling for $953.10 and pays 8% coupon annually. Interest rates during the next three years are 8%, 10%, and 12%, respectively. What are the YTM and realized compound yield of this bond? Fall 2010 Investment Manageme nt, Lecture 13 4 Realized Return vs. YTM – Cont’d • Suppose that you buy a bond. Will the return on your investment be equal to the YTM ? • Realized return = YTM if and only if : ▫ you can reinvest the coupons at the same rate, and ▫ you hold the bond until maturity • In most cases it will be different because: ▫ you must reinvest the coupons at a different Fall 2010 Investment Manageme nt, Lecture 13 5 Bond Prices Over Time Consider a bond that pays annual coupon issued several years ago sold at par value of $1,000 when the interest rate was 7%. The market interest rate has now risen to 8%, and the bond has three years until maturity. Ø What is the price of the bond today? Ø If market interest rate does not change further, what would be the price of the bond in one year? Ø What is the holding period return over this year? Ø Suppose that by the end of the first year, the bond’s YTM is 8.5%. What is the oneyear HPR? Compare it to the bond’s initial YTM of 8%. Fall 2010 Investment Manageme nt, Lecture 13 6 How to Get Yields from STRIPS Strips stands for Separate Trading of Registered Interest and Principal of Securities, as well as the fact that the coupon payment is effectively "stripped“ from the bond principal....
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This note was uploaded on 02/28/2012 for the course FINE 441 taught by Professor Ruslangoyenko during the Spring '08 term at McGill.
 Spring '08
 RUSLANGOYENKO

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