Book 4_Fixed_READING 54_FIXED INCOME BOND VALUATION_PRICES AND YIELDS Flashcards
The price of a bond
is the present value of its future cash flows, discounted at the bond’s yield to maturity.
For an annual coupon bond with N years to maturity
price = coupon/(1+ YTM)+…+
For an semiannual coupon bond with N years to maturity
price = coupon/(1+ YTM/2)+…+
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
= the coupon payment x the portion of the coupon period from the previous payment date to the settlement date.
Steps to calculate flat price
Step 1: Calculate the value of the bond on the last coupon date.
Step 2: Calculate at the settle date
Step 3: Calculate the accrual interest
A bond’s price and YTM
- are inversely related.
- An increase in YTM decreases the price, and a decrease in YTM increases the price.
Bond prices are convex with respect to yield movements
which means price increases when yields fall are greater in magnitude than the fall in prices caused by an equivalent yield rise.
A bond will be priced
- at a discount to par value: coupon rate < YTM (deficient coupon)
- at a premium to par value: coupon rate > YTM (excessive coupon)
Prices sensitivity
- More sensitive to changes in YTM for bonds with lower coupon rates and longer maturities,
- 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.
methods to count the days
- actual/actual convention
- 30/360 convention
Matrix pricing
is a method used to estimate the yield to maturity for bonds that are not traded or infrequently traded
Estimate the yield based on traded bonds
- both are the same credit quality.
- If different maturities, linear interpolation is used to estimate the subject bond’s yield.
