Chapter 7 Fixed-income Securities Pricing and Trading
Calculating price and yield of a bond
The discount rate
the rate at which you would discount a future value to determine the present value
coupon ( if twice a year: 9%/2 = 4.5% per period
compounding periods
4 years * 2 payments per year = 5% per period
discount rate: 10%/ 2 payments per year= 5% per period
Calculating the fair of a bond
the fair price for a bond is the sum of : the present value of its principal and the present value of its coupon
Calculating the yield on a treasury bill
Yield= （100 - Price） / Price （365/ Term） 100
Calculating the current yield on a bond
Current Yield = (Annual Cash Flow/ Current Market Price) * 100
Calculating the yield to maturity on a bond
AYTM= interest income +or- price per compounding period / (purchase price + par value)/2 * 100
reinvestment risk
the risk that the coupon will earn a return at a lower overall rate than the rate that prevailed at the time that the bond was purchased is called reinvestment risk
a zero coupon bond (strip bond) has no investment risk
term structure of interest rates
Calculate what bond is worth in the secondary market = the present value of the bond
The real rate of return of a bond (investment)
made up of 2 components
Nominal rate 名义利率= Real rate - inflation rate
the real rate of return
the inflation rate
2 factors affect forecasts for the real rate
rises and falls throughout the business cycle
unexpected change in the inflation
The yield curve
Expectation theory
the current long-term interest rates foreshadow future short-term rates
a single long-term bond should expect to earn the same amount of interest as they would buying 2 short-term bonds of equal combined duration
e.g. 2 year return= 1 year return (Year 1 ) * 1 year return (Year 2 )
Liquidity preference theory
investors prefer short-term bonds because they are more liquid and less volatile
Market segmentation theory
institutional players in the fixed-income arena each concentrate their efforts in a specific term sector
e.g. chartered banks tend to invest in the short-term market; life insurance mainly in long-term bond sector
the yield curve are primarily influenced by the bigger players in each sector
The normal shape suggests that short-term rates are lower than long-term rates.
The most common shape for the yield curve is the normal curve. This shape occurs when long-term yields are higher than short-term yields and is thought to reflect the risk premium that investors require for holding longer term fixed-income securities.
Fundamental bond pricing properties
The relationship between bond prices and interest rates
inverse relationship: as interest rates rise, bond prices fall, bond yield rise
The impact of maturity
longer-term bonds are more volatile in price than shorter-term bonds
as bonds approach maturity over the years, they become less volatile ( a 10 year bond, 7 years later, it has 3 year term; it will be priced as 3-year bond)
The impact of the coupon
lower-coupon bonds are more volatile in price percentage change than high-coupon bonds
The impact of yield change
bond prices are more volatile when interest rates are low
Duration as a measure of bond price volatility
Duration
a higher duration: a higher percentage price change for a given change yield ( high duration = more volatile)
the impact of both the coupon rate and the term to maturity
a measure of the sensitivity of a bond's price to changes in interest rates
approximate percentage change in the price or value of a bond for a 1% change in interest rates
Bond market trading
The sell side
investment banker
trader
sales representative
The buy side
portfolio manager
trader
structure new debt issues and bring new issues to the primary market
trade securities in the secondary market
Buying bonds through an investment dealer
Trading in firms with a large institutional dealing desk
Trading in firms without a large institutional dealing desk
help the advisors by sourcing products and providing market commentary
investment advisors are served by a trading desk as the source of product
Role of inter-dealer broker
inter-dealer brokers
act as agent; bring together buyers and sellers in matching trades
Mechanics of the trade
trade ticket
an electronic confirmation sent through secure, proprietary systems
Clearing and settlement
Government of Canada T-bills settle on the same day of the transaction; other securities settle on the second clearing day after the transaction takes place
fixed-income securities ownership
Bearer bonds 不记名债券
ownership is signified by physical possession
Registered bonds
can be sold or transferred only when the owner signs the back of the certificate
Bonds registered in book-based format
an electronic record keeping system used by depositories that keeps track of ownership and transaction
risk of losing certificates
demand for liquidity and cheaper and faster way to bring issues to the market
most bonds issues globally are issued in a book-based format
Calculating accrued interest
Accrued interest= par amount (coupon rate/100) (time period/ 365)
Bond index
large trade/ non-electronic trades take place over the phone
most trades take place using the system
day period: the day after the previous interest payment date up to and including the day of settlement
as a guide of the performance of the overall bond market or a segment of that market
as a performance measurement tool
to construct bond index funds
Canadian bond market indexes
FTSE Canada Universe Bond Index
the annual income from an investment expressed as a percentage of the investment's current value