FIN-2Lecture 9-The Term Structure of Interest Rates and Yield Derivation

If each cf can be sold off or bought as a separate

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Unformatted text preview: e zerocoupon bond Investors’ Bond Pricing § § § These are what are known as Treasury STRIPS – Separate Trading of Registered Interest and Principal of Securities. If each CF can be sold off (or bought) as a separate security, then the value of the whole bond should be the same = Total PV of CFs If this was not the case, there would be ‘Arbitrage’ – exploitation of mispricing among two or more securities to make a riskless profit. Bond Y FV = €1,000 Coupon 4% p. a PRICE = €751.31 PRICE = €850.79 Bond X FV = €1,000 Coupon 0% p. a Yield 10% Yield 10% TTM = 3 years TTM = 3 years Investors’ Bond Pricing § Take a closer look at Bond Y. You can buy it as a single bond, or you can buy 3 separate zero-coupon bonds (STRIPS) at the same price today! Bond YA CF = €40 Bond YB FV = €40 Bond YC FV = €1,000 + €40 Coupon 0% p. a Coupon 0% p. a Coupon 0% p. a Yield 10% Yield 10% Yield 10% TTM = 1 year TTM = 2 years TTM = 3 years PRICE = €36.36 PRICE = €33.06 TOTAL OF THE WHOLE = €850.79 PRICE = €781.37 Investors’ Bond Pricing § Look at the three bonds as constituting a portfolio. The yield on the coupon bond is then a combination of the yields on each of the three components of the portfolio. § This means that bonds of the same maturity but with different coupon rates will not have the same yield. § This is what the yield curve tells us. It is a plot of yields on zero-coupon bonds or de-constituted coupon bonds (STRIPS) § From a yield curve we are told how to price 1-, 2-, 3-, The Yield Curve § Pure Yield Curve – this in the plot of yields on zerocoupon bonds § On-the-run Yield Curve – the plot of yields as a function of Maturity for recently issued coupon bonds selling at or near face value (par). § Yield curves published in the newspapers is an onthe-run curve most of the time reflecting government treasuries § Real Yield Curve – the...
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