Appendix 9
Cash Flows of MBS
How to compute the expected Cash flows of a MBS given certain CPR or PSA
assumption?
o First, figure the constant Mortgage payment (MP) for the life of the mortgage
o Given CPR or PSA assumption, compute the SMM for each month
Fixed Income, Francis Ng
Appendix 7
Partial durations
What are partial durations?
o Partial duration is defined as the local duration of a bond or a portfolio of bonds
with respect to a particular term on the yield curve.
o Most people look at the partial
Fixed Income, Francis Ng
Appendix 6A
Convertible Bond Arbitrage
o Whats convertible bond arbitrage?
o Recall that a CB has a straight bond + a call option to convert into
shares
Price (CB) = Price (Bond) + Price(Call Option)
CB / S = Call / S = Delta of c
Fixed Income
Francis Ng
Appendix 4A
Approximate Duration and Convexity
o Modified duration is easily defined and computed when cash flow is fixed.
o What if the cash flows of the bond or security are highly uncertain such as
Mortgage Backed Securities (MB
Fixed Income
Francis Ng
Appendix 2A
Make Whole Call
o Make Whole Call is an implicit call option embedded in the bond structure.
o This means an issuer can call the bond at any time (if there is no protection
period).
o But the issuer must buy back all th
Appendix 1A
Fixed Income, Francis Ng
REPO Revisited
Case A: Repo
Purpose: To fund a bond purchase
Transaction: Trader Sell / Buy with Repo dealer
At time t (1st leg)
buy bond @ P0
Market
deliver bond to dealer
Trader
pay P0
get (P0 HC)
Repo
Dealer
CF(0) t
Fixed Income
Lecture #13
Interest Rate Swap
Swap
This is a derivative contract between two parties to
swap a series of fixed payments for a series of
future payments (floating payments)
From FRA, we understand that it is also a contract
between 2 parties.
Fixed Income
Lecture #12
Forward rates & FRA
(part of chapter 5)
Forward Rates
Suppose, you were faced with a decision to either:
1. Invest $1000 in a 1-year CD at 5.85% and roll over
to a new 1-yr CD.
2.
Invest $1000 in a 2-year CD at 6.03%
Question: Whi
Fixed Income
Lecture #11
Convertible Bonds
Convertibles
Definitions
1. Convertible bond is a bond whereby bondholders are
granted the right to convert the bond into a
predetermined number of shares of common stock of the
issuer.
2.
Convertible bond is a c
Fixed Income
Lecture #9
Corporate Debt
Corporate Debts
Corporate debt instruments are financial obligations of
a corporation that have priority over its common stock
and preferred stock in the case of bankruptcy.
4 types of Corporate issuers:
1. utilities
Fixed Income
Lecture #7
Convexity
Convexity
Modified Duration = -1*(dP/dy)(1/P)
Modified Duration :
the slope of the price-yield bond curve
The first derivative of the price-yield curve
The first-order risk with respect to interest rate
The interest-r
Fixed Income
Lecture #6
Bond Price Volatility
Bond Price Volatility
Why Bond prices change?
For fixed-rate (option-free) bonds, the price will change
inversely as yield changes.
This is the price-yield convex relationship
As market interest rates change,
Fixed Income
Lecture #5
Total Return of bond
Total Return (TR)
Total Return of a Stock Investment
1. Dividend (if any)
2. Reinvestment of dividends
3. Capital gain
Total Return (TR) of a Bond Investment
1. Coupon payments
2. Reinvestment of interest
3. Ca
Fixed Income
Lecture #4
Measuring Yield
Bond Yield
Yield
1.
Its the interest rate (discount rate) that will make
the PV of the CFs from the investment equal to the
price (or cost) of the investment.
n
P = CF(t)/(1+y)t
2.
3.
This is also known as IRR since
Fixed Income
Lecture #3
Bond pricing: Part 2
Bond Pricing
Pricing a Zero-Coupon bond
Zeros do not pay interest
Interest = $Face Value $Purchase price
If you hold bond to maturity (N years), then
each years implied interest is (FV Purchase
Price)/N
And
Fixed Income
Lecture #2
Bond pricing
Review of TVM
1) Future value: Case 1
Suppose you invest an amount equals to P(0) (say,
$1,000) at an annual interest rate of 5%
How much do you get back 3 years from now if interest
is paid once a year?
P(3) = P(0) *(
Fixed Income
Lecture #1
Introduction
Bond Features
Whats a bond?
A bond is a debt instrument requiring the borrower to
repay to the lender the amount borrowed plus interest
over a specified period of time.
Borrower is also known as the Issuer
Lender or