(R44) Introduction to Fixed-Income Valuation Flashcards
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 (use time value of money keys)
Discount or premium bond when coupon rate < YTM
Discount bond; premium bond is when coupon rate > YTM
Identify relationship among bond price and discount rate
Bond price is inversely related to the discount rate; when price goes up, rate goes down (this is called the inverse effect)
What is the convexity effect relationship for bond price?
Given the same coupon and time to maturity, the % change in price is greater when rates are decreasing compared to when rates in increases
What is the coupon effect relationship for bond prices?
Lower coupon bond is more price sensitive than a higher coupon bond when rates change, given the same time to maturity
What is the maturity effect relationship for bond prices?
For the same coupon rate: a longer term bond is more price sensitive than a shorter-term bond
Spot rate and calculation of PV using spot rates
Spot rates are market discount rates for single payments to be made in the future (each payment in the future has a different rate); PV = [PMT/(1+S1)] + [PMT/(1+S2)] + [PMT/(1+Sn)]
When a bond is between coupon dates, its price has two parts:
1) the flat price (PVflat) and 2) accrued interest (AI); the sum of these equal PVfull
Formula to calculate accrued interest for bonds
Accrued interest = t/T x PMT (where t = # of days between last payment and settlement date; T = # of days between each payment)
Two conventions to count days for calculating accrued interest and PVfull
30/360 (used for corporate bonds) and actual/actual (used for gov’t bonds)
Formula for PVfull
PVfull = PV x (1+r)^(t/T)
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 comparable bonds (i.e. similar tenor, coupons, credit quality).
Difference between effective annual rate and semi-annual bond basis yield
Effective annual rate is for bonds with a periodicity of 1 (1 coupon/year); Semi-annual bond basis yield is for bonds with a periodicity of 2 (2 coupons/year).
Relationship between periodicity and annual percentage rate
As periodicity increases, APR decreases
Formula for periodicity conversions (semi to quarterly)
[1 + (r/2)]^2 = [1+(r/4)]^4