Bond Flashcards
What is a dirty price
Dirty price is actual PV of the all future cash flow, but when calculating
clean price = Dirty price - Accrued interest
How you calculate bond risk
We look at yield and price relationship of bond.
Then we analyse the effect of yield change on the price how sensitive it is.
When we get a small change in the interest rate , we use calculation method called duration.
when we get a larger change in the interest rate we use method called convexity.
What is a Macaulay’s duration?
It is basically a measure of the length of time that yield effect to be balanced out between two effects, which are price effect and reinvestment effect. Macaulay’s duration assesses 1% change in the yield.
After Macaulay’s duration the bond will generate profits.
Modified Duariton?
It is just an elasticity of price on yield change. In other words to see the effect of delta y on delta p or vise versa.
= - 1/(1+y) x Macaulay’s duration
If calculating a basis point change then modified duration must be multiplied by 0.0001
the result is the effect os a basis point change
What are the Macaulay’s Duration formula?
(i x Ci) / (1+y)^i and (n x M) / (1+y)^n
How far the duration method makes error?
it is 0.5 x convexity measure x (delta y)^2
what is the Convexity annual equal if there were m period for coupon?
convesity annual = convexity in m period per year / m^2
Term structure of interest rate
We are trying to analyse what would yield curve look like( theoritically) and see if actual yield curve differ from the theoritical expectations or not. The point is it will help for investor who is buying a bond by allowing to make a comparison to a treasury bond combination which is the theoritical benchmark.
When would you see inverted yirld curve?
SR yield > LR yield
post crisis
Determinant of the shape of the term structure
Two major theories have evolved to account for these observed shapes of the yield curve:
Expectations theories
Pure expectations theory - entire term structure at a given time reflects the market’s current expectations of the family of future short-term rates.
Liquidity theory - reason why it is upward
sloping
Preferred habitat theory. - mid term creates
hump shape why?
Market segmentation theory. - the reason for
hump shape is might be due to
regulation
Analysis of whether or not non residents have an impact on bond price?
It is evident fact studied by IMF that post crisis some countries non resident bond holders moved away namely PIGS. Non resident interestingly had huge demand prior to crisis, obviously it was associated with asset bubble that happened around the world. Huge increase in reserve currencies occured, mainly due to fact that surplus countries were not saving in their own currencies but instead they saved it in US and UK .
It implies the high demand for US bonds therefore US dollars were required to buy those bonds and US governent in fact did double QE to facilitate those dollar needs, in turn surplus countries bought US bonds.
However recently demand is falling due to reduction in interest by surplus countries namely Oil producers and China. But the overall demand still remains higher due to EU being in economic trouble.
Another Point is that Basel agreements did not require capital against government bonds=> hence contributed the high demand for government bonds
But what we are seeing in rrecent years is that deleveraging.
The question is does the investor base matter for bond price?
impirical data might have an interpretation of non resident inflow lifted the governement bond price.
The findings in relation to above question was that a strong and robust association of lower yields with a larger share of non-resident holdings.
Yields are weakly and negatively associated with institutional investor holdings, but not with public sector holdings.
Higher non-resident holdings are associated with an increase in the volatility of yields.
While these results establish an empirical relationship between yields and non-resident and institutional investor holdings, the causality can go either way.
