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    Fixed Income

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    This document provides an overview of key concepts in fixed income markets, including: 1) Bond indentures are contracts that define the terms of bonds, and floating rate securities set coupon rates as a reference rate plus or minus a quoted margin. Bonds have risks related to interest rates, credit, liquidity, and other factors. 2) Yield curves can shift in parallel or non-parallel ways. Duration measures the sensitivity of bond prices to changes in yields but is not accurate for portfolios with non-parallel shifts. 3) Treasury securities include bills, notes, and bonds of different maturities. Mortgage-backed securities and collateralized mortgage obligations allow investors to match liquidity preferences.

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    Download as PDF, TXT or read online from Scribd

    Fixed Income

    Uploaded by

    api-294072125
    115 views3 pages
    This document provides an overview of key concepts in fixed income markets, including: 1) Bond indentures are contracts that define the terms of bonds, and floating rate securities set coupon rates as a reference rate plus or minus a quoted margin. Bonds have risks related to interest rates, credit, liquidity, and other factors. 2) Yield curves can shift in parallel or non-parallel ways. Duration measures the sensitivity of bond prices to changes in yields but is not accurate for portfolios with non-parallel shifts. 3) Treasury securities include bills, notes, and bonds of different maturities. Mortgage-backed securities and collateralized mortgage obligations allow investors to match liquidity preferences.

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    This document provides an overview of key concepts in fixed income markets, including: 1) Bond indentures are contracts that define the terms of bonds, and floating rate securities set coupon rates as a reference rate plus or minus a quoted margin. Bonds have risks related to interest rates, credit, liquidity, and other factors. 2) Yield curves can shift in parallel or non-parallel ways. Duration measures the sensitivity of bond prices to changes in yields but is not accurate for portfolios with non-parallel shifts. 3) Treasury securities include bills, notes, and bonds of different maturities. Mortgage-backed securities and collateralized mortgage obligations allow investors to match liquidity preferences.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    115 views3 pages

    Fixed Income

    Uploaded by

    api-294072125
    This document provides an overview of key concepts in fixed income markets, including: 1) Bond indentures are contracts that define the terms of bonds, and floating rate securities set coupon rates as a reference rate plus or minus a quoted margin. Bonds have risks related to interest rates, credit, liquidity, and other factors. 2) Yield curves can shift in parallel or non-parallel ways. Duration measures the sensitivity of bond prices to changes in yields but is not accurate for portfolios with non-parallel shifts. 3) Treasury securities include bills, notes, and bonds of different maturities. Mortgage-backed securities and collateralized mortgage obligations allow investors to match liquidity preferences.

    Copyright:

    © All Rights Reserved
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    of 3

    Fixed Income

    Bond Indenture = contract


    Cap + Floor = Collar
    Floating rate securities: New Coupon Rate = reference rate +/- quoted margin
    Full or dirty price = clean price + accrued interest
    Call protection - period it cannot be called
    Non-refundable = cannot be called using proceeds from lower bond issue
    Sinking fund = retires X amount per year

    Interest Rate Risk (Duration) longer maturity ; lower coupon ; lower yield
    Yield Curve Risk; Call Risk; Prepayment Risk; Credit Risk; Liquidity Risk; Exchange rate risk; Inflation Risk;
    Volatility Risk; Event Risk; Sovereign Risk
    Yield Curve Shifts Parallel shifts VS non-parallel shifts
    Parallel all bonds within a portfolio change by the same absolute percent amount
    Non parallel = duration is poor approximation of sensitivity of portfolio, must calc key rate durations
    Primary Market = underwriting; bought or best efforts; Auction process or private placement
    2nd ary market = OTC; exchanges; etc
    Duration = - % bond price / % yield
    Sovereign Bonds
    Treasury Securities:
    Bills = no coupons, sell @ discount to par (28, 91, 182 days)
    Notes = semiannual coupon (2,3,5,10 years);

    Bonds = 20 or 30 years

    Treasury Bond / Note: quoted in % and 32s of % face value ex (102-5 is 102 + 3/32 = 1.0215625)
    TIPS : Treasury Inflation Protected Securities
    Fixed coupon paid semi-annually X % of inflation adjusted par value
    TIPS coupon = adjusted par value X stated coupon / 2

    MBSs are backed by pools of mortgages.


    CMOs: tranches: interest only until previous tranches are paid off, then principle + interest; allows
    to match liquidity preferences
    Insured bonds: pre-refunded bonds: special escrow account w sufficient treasury securities to
    satisfy existing bond obligations.
    Structured Medium term notes; step up notes; inverse floater; deleveraged floaters; dual index
    floaters; range notes; index amortizing notes;
    Commercial paper = 270 days or less
    CDOs: pools and tranches like CMOs.

    Pure Expectations Theory; Liquidity Preference Theory; Mkt Segmentation Theory


    Spot Rates
    Absolute Yield Spreads = yield on higher yield on lower
    Relative Yield Spread = Absolute Yield Spread / yield on benchmark bond
    Yield Ratio = subject bond yield / benchmark bond yield (or 1 RYS)
    Expanding economy:

    spreads narrow (decline)

    Contraction economy: spreads widen (junk bonds need to offer much higher rate)
    Current yield = annual cash coupon / bond price
    YTM = Annualized IRR (assumes cfs are reinvested at YTM rate and bond is held to maturity)
    YTM > coupon -> discount bond;

    YTM < Coupon -> premium bond

    BEY = 2 X semiannual discount rate OR =


    YTC; YTFC; YTPar Call; YTWorst; YT refundings; YT put; CFY
    Realized Yield = initial investment only
    BEY of Annual =

    [(1 + annual YTM)1/2 1] X 2

    EAY of Semi

    (1 + YTM Semi / 2)2 1

    Three year spot rates; deriving forward rates, etc


    Nominal yield spread = simple YTM bond YTM treasury

    ZVS
    = equal amount that must be added to each rate on T spot yield curve to make PV of risky
    bonds cash flows equal to its market price
    = steeper the spot rate curve, greater the ZVS & nominal S difference
    Spot rate curve upward sloping: ZVS ;

    S yield curve ive sloping: ZVS < NS

    The earlier the principle is repaid, greater the differences in spread measures
    OAS = measure used when bonds have embedded options; Spread it would have had if the option was
    gone
    Z spread OAS = option cost in %
    Callable Bonds: Z-spread > OAS and option cost > 0; Putable = ZVS < OAS; option < 0;

    Full Valuation = stress testing


    Duration / convexity approach
    Positive convexity increases more when yields fall than it decreases when yields rise
    bonds price falls @ decreasing rate as yields rise.
    Duration of a bond @ any yield is slope of price yield relation. (duration is less @ higher yields).
    Negative Convexity callable & prepayable securities
    Put-able bonds
    Effective duration =

    (bond price when yields fall + bond price when yields rise)
    2 X initial price X ( in yield)
    =

    V- + V+ - / (2)(Vo)(y)

    Macaulay Duration = estimate of a bonds interest rate sensitivity based on time (option free only)
    Convexity = measure of curvature of price yield curve
    % price

    duration effect + convexity effect

    { [ - duration X (y)] + [ convexity X (y)2] } X 100

    PVBP = duration X 0.0001 X bond value

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