Introduction to Fixed Income Valuation Flashcards
Calculate bond price
The price of a bond is the present value of its future cash flows, discounted at the bond’s yield-to-maturity.
Annual
Coupon
/
(1YTM) n
Summed. Remember to raise payments to a power if they are not in the first period and include the principal payment and coupon in the last payment
Semi
Coupon
/
(1+YTM) n x 2
Explain the relationship for a bonds price and its YTM. Which way is it more sensitive?
A bond’s price and YTM are inversely related.
Prices are more sensitive to a decrease in YTM than they are to an increase.
e.g prices go up faster than they go down.
Calculate the value of a bond using spot rates
Coupon
/
(1+S1)
+
Coupon
/
(1+S2)2
Coupon + principle
/
(1+s3)n
Calculate the full price of a bond
Calculate accrued interest
PV x (YTM) t/T
t/T x PMT
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 (PV)
Calculate accrued interest. What are the two ways of doing this?
What do you need to remember
Coupon Payment x (portion of coupon period since last payment date)
Ways
Corporate: 30/360
Government Actual/Actual
Remember: for semi annual payments, this will be n/180
What is street convention and true yield
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.
Explain matrix pricing including linear interpolation
1 - for bonds with same term, use average YTM
2 - use linear interpolation
e.g
Bond x 4 year YTM x?
Bond 1 3 years YTM 5.1%
Bond 3 6 years YTM 6.6%
1 2 3(b1) 4(bond x) 5 6 (b2)
Bond x is 1/3 of the way between b1 and b2.
“take 1/3 of the difference and add it”
Difference 1.5 / 3 = 0.5.
Bond X YTM = 5.6 :)
What is the current yield and what are the drawbacks
Annual Coupon payment
/
bond price
Drawbacks: ignores movement to par value which means for discount bonds the current yield will always be lower than the YTM. For premium, the opposit (current yield higher than YTM).
Explain how FRNs are priced
Explain the reasons for differences between quoted and required margin
Floating rate notes 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 greater than the quoted margin if credit quality has decreased, or less than the quoted margin if credit quality has increased.
What is A yield spread and what are the different forms of yield spread
A yield spread is the difference between a bond’s yield and a benchmark yield or yield curve.
If the benchmark is a government bond yield, the spread is known as a government spread or G-spread.
If the benchmark is a swap rate, the spread is known as an interpolated spread or I-spread
Convert to Bond Equivalent Yield
1 - calculate HPY
2 - adjust for periods (annualise etc)
Calculate Simple yield
PMT +- amortization of premium / discount(SL)
/
Bond price
Calculate FWD rate from spot rate
1 Multiply rates by periods outstanding
2 Calculate the difference between the relevant periods
3 Annualize / de annualize if necessary
Calculate Spot from FWD rate
Harmonic mean
(%+%+%) /n
What does YTM assume
- Bond held to maturity
- All payments made
- coupon payments are re-invested at YTM
