Investment Course - 2005. Day Three: Fixed-Income Analysis and Portfolio Strategies. The Role of Fixed-Income Securities in the Financial Markets and Portfolio Management. U.S. & Chilean Yield Curves: Feb 2004 – Feb 2005. U.S. Yield Curve and Credit Spreads: February 2005.
Fixed-Income Analysis and Portfolio Strategies
(i) Holds the bond until maturity,
(ii) Reinvests all intermediate cash flows (i.e., the first two coupons) at the same 10% rate for the remaining time until maturity.
P = F <===> C/F = C/P = y
The bond is priced at par value since its coupon rate is "fair" in that it equals the current market interest rate as represented by the yield-to-maturity.
P > F <===> C/F > C/P > y
The bond is priced at a premium above par value since its coupon rate is "high" given current market rates. A par-value, current coupon bond would have a lower coupon rate, so the premium represents the value of the "excessive" coupon cash flows. In fact, the amount of the premium is the present value of the annuity represented by the difference between the coupon rate and the bond's yield, discounted at that yield.
P < F <===> C/F < C/P < y
The bond is priced at a discount below par value since its coupon rate is "low" given current market rates. The amount of the discount is the present value of the annuity represented by the difference between the yield and the coupon rate. For example, a zero-coupon bond will usually be at a deep discount to par value.
Implication: When market rates fall, bond prices rise, and vice versa.
Implication: Long-term bonds are riskier than short-term bonds for a given shift in yields, but also have more potential for gain if rates fall.
Implication: Low-coupon bonds are riskier than high-coupon bonds given the same maturity, but also have more potential for gain if rates fall.
Implication: There are potential gains from structuring a portfolio to be more convex (for a given yield and market value) since it will outperform a less convex portfolio in both a falling yield market as well as a rising yield
Convex Price-Yield Curve
Bond A: (906.43 - 924.18) / (924.18) = -1.92% (least)
Bond B: (668.78 - 705.46) / (705.46) = -5.20% (most)
Bond C: (952.68 - 1000.00) / (1000.00) = -4.73% (middle)
So, percentage change:
Bond D: (768.31 - 807.93) / (807.93) = -4.90%
DMV ~ -(Mod D)( Dy)(MV)
DMV ~ -(Mod D)(0.0001)(MV) = Basis Point Value = BPV
Max(0,% SPX Rtn)
SPX Index Call Option