session4 - Session 4 Bonds & Interest Rates Bond Basics...

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Session 4 Bonds & Interest Rates
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2 Bond Basics Straights Markets Issuers, currency Maturity Coupons Redemption
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3 Present Value “Going” yield on safe assets is 5% HMT offers £105 in one year’s time What is this IOU worth today? What if yields were zero!
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4 Price-Yield Relation 80 85 90 95 100 105 110 0% 5% 10% 15% 20% 25% Price Yield
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5 Simple Discounting ? = °± − ²± ²± 1 + ? = °± ²± ²± = °± 1 + ? ? = yield, discount rate °± = redemption value ²± = present value 1 1 + ? = discount factor
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6 Extending the Horizon Say government borrows £105 for 2 years 5%? 10%? zero? What is the present value of the “gilt” when risk -free yields are. .....
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7 Multi-Year Discounting at 5% yield, £105 in two year’s time is worth £95.24 today put example on it’s head: what would £95.24 be worth in two year’s time if invested at APR of 5%? 95.24 (1.05) 2 = 105! °? = ±? (1 + ² ) ? In general
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8 Price-Yield Relation 0 20 40 60 80 100 120 0% 5% 10% 15% 20% 25% Price Yield 1yr 2yr 10yr 20yr
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9 Price Sensitivity % change in present value if yield rises from 5% to 6% -20% -15% -10% -5% 0% 1yr 2yr 10yr 20yr
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10 Coupon Bonds Fixed coupons Fixed yield Annual payments °? = ? 1 + ± + ? 1 + ± ² 2 + ? 1 + ± ² 3 + . + ? + ³? 1 + ± ² ? = ? ´ 1 1 + ± ² µ ? µ =1 + ³? 1 + ± ² ? ? = maturity (years)
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