(53) Introduction to Fixed-Income Valuation Flashcards
LOS 53. a: Calculate a bond’s price given a market discount rate.
The price of a bond is the present value of its future cash flows, discounted at the bond’s yield-to-maturity.
LOS 53. b: Identify the relationships among a bond’s price, coupon rate, maturity, and market discount rate (yield-to-maturity).
A bond’s price and YTM are inversely related. An increase in YTM decreases the price and a decrease in YTM increase the price.
A bond will be priced at a discount to par value if its coupon rate is less than its YTM, and at a premium to par value if its coupon rate is greater than its YTM.
LOS 53. b: Identify the relationships among a bond’s price, coupon rate, maturity, and market discount rate (yield-to-maturity).
Prices are more sensitive to changes in YTM for bonds with lower coupon rates and longer maturities, and less sensitive to changes in YTM for bonds with higher coupon rates and shorter maturities.
A bond’s price moves toward par value as time passes and maturity approaches.
LOS 53. c: Define spot rates and calculate the price of a bond using spot rates.
Spot rates are market discount rates for single payments to be made in the future.
The no-arbitrage price of a bond is calculated using (no-arbitrage) spot rates as follows:
LOS 53. d: Describe and calculate the flat price, accrued interest, and the full price of a bond.
The full price of a bond includes interest accrued between coupon dates. The flat price of a bond is the full price minus accrued interest.
Accrued interest for a bond transaction is calculated as the coupon payment times the portion of the coupon period from the previous payment date to the settlement date.
Methods for determining the period of accrued interest include actual days (typically used for government bonds) or 30-day months and 360-day years (typically used for corporate bonds).
LOS 53. e: Describe matrix pricing.
Matrix pricing is a method used to estimate the yield-to-maturity for bonds that are not traded or infrequently traded. The yield is estimated based on the yields of traded bonds with the same credit quality. If these traded bonds have different maturities than the bond being valued, linear interpolation is used to estimate the subject bond’s yield.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. What does the effective yield of a bond depend on?
The effective yield of a bond depends on its periodicity, or annual frequency of coupon payments. For an annual-pay bond the effective yield is equal to the yield-to-maturity. For bonds with greater periodicity, the effective yield is greater than the yield-to-maturity.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. What is the yield-to-maturity (YTM) quoted on a semiannual bond basis equal to?
A YTM quoted on a semiannual bond basis is two times the semiannual discount rate.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. Define bond yields that follow street convention and true yields.
Bond yields that follow street convention use the stated coupon payment dates. A true yield accounts for coupon payments that are delayed by weekends or holidays and may be slightly lower than a street convention yield.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. Define current yield and simple yield.
Current yield is the ratio of a bond’s annual coupon payment to its price. Simple yield adjusts current yield by using straight-line amortization of any discount or premium.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. Define yield-to-call and yield-to-worst.
For a callable bond, a yield-to-call may be calculated using each of its call dates and prices. The lowest of these yields and TYM is a callable bond’s yield-to-worst.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments. Define floating rate notes, quoted margin, and required margin.
Floating rate notes (FRN) have a quoted margin relative to a reference rate, typically Libor. The quoted margin is positive for issuers with more credit risk than the banks that quote Libor and may be negative for issuers that have less credit risk than loans to these banks. The required margin on a floating rate note may be grater than the quoted margin if credit quality has decreased, or less than the quoted margin if credit quality has increased.
LOS 53. f: Calculate and interpret yield measures for fixed-rate bonds, floating-rate notes, and money market instruments.
For money market instruments, yields may be quoted on a discount basis or an add-on basis, and may use 360-day or 365-day years. A bond-equivalent yield is an add-on yield based on a 365-day year.
LOS 53. g: Define and compare the spot curve, yield curve on coupon bonds, par curve, and forward curve. Define a yield curve.
A yield curve shows the term structure of interest rates by displaying yields across different maturities.
LOS 53. g: Define and compare the spot curve, yield curve on coupon bonds, par curve, and forward curve. Define a spot curve.
The spot curve is a yield curve for single payments in the future, such as zero-coupon bonds or stripped Treasury bonds.