Capital Markets Dr. Ian Giddy New York Universitygiddy.org/sf/nibcapital/nib-bonds.pdfThese are...

Dr.

Ian

Gid

dy

New

Yor

k U

nive

rsity

Cap

ital M

arke

ts

NIB

C

3Copyright ©2006 Ian H Giddy

Cap

ital M

arke

tsC

apita

l Mar

kets

�D

ay 1

�T

he B

ond

Mar

kets

�M

ezza

nine

Fin

ance

�D

ay 2

�F

ixed

-Inc

ome

Der

ivat

ives

�S

truc

ture

d N

otes

�D

ay 3

�A

sset

-Bac

ked

Sec

uriti

es

�C

DO

san

d C

redi

t Der

ivat

ives

Dr.

Ian

Gid

dy

New

Yor

k U

nive

rsity

The

Bon

d M

arke

ts

NIB

Cap

ital


The

Fix

edT

he F

ixed

-- Inc

ome

Mar

kets

Inco

me

Mar

kets

�T

reas

ury

bills

, not

es a

nd b

onds

�O

ther

gov

ernm

ents

and

tax-

exem

pts

�C

orpo

rate

bon

ds

�M

ortg

age-

back

ed s

ecur

ities

�E

urob

onds

and

fore

ign

gove

rnm

ent b

onds

�S

wap

s an

d ot

her

fixed

-inco

me

deriv

ativ

es

�S

truc

ture

d no

tes

How

can

we

mak

e se

nse

of a

ll th

ese?


Ris

k-F

ree

Ass

et

Bon

dsR

eal E

stat

e

Con

Ed

Via

com

Cha

seS

iem

ens

Sec

urity

Sel

ectio

n

Sto

cks

Com

mod

ities

FX

Ass

et A

lloca

tion

Ris

ky A

sset

s

Cap

ital A

lloca

tion

Man

agin

g a

Por

tfolio

Man

agin

g a

Por

tfolio


Fix

ed In

com

e M

arke

tsF

ixed

Inco

me

Mar

kets F

ixed

Inco

me

Fix

ed In

com

e

Mon

ey M

arke

tsM

oney

Mar

kets

Bon

dsB

onds


Mon

ey M

arke

tsM

oney

Mar

kets

Sou

rce

: ft

.co

m


The

Glo

bal M

oney

Mar

ket

The

Glo

bal M

oney

Mar

ket

Sou

rce

: ft

.co

m


The

Bon

d M

arke

tT

he B

ond

Mar

ket

Mun

icip

al B

onds

Ass

et-B

acke

d S

ecur

ities

For

eign

Bon

ds

Eur

oyen

Bon

ds, e

tc.

Eur

obon

ds

Cor

pora

te B

onds

Gov

ernm

ent B

onds

Priv

ate

Pla

cem

ents


Glo

bal M

arke

tG

loba

l Mar

ket

Source: imf.org, Global Financial Stability Report


The

US

Bon

d M

arke

tT

he U

S B

ond

Mar

ket

Sou

rce

: b

on

dm

ark

ets

.co

m, R

ese

arc

h Q

ua

rte

rly


Gov

ernm

ent B

onds

Gov

ernm

ent B

onds

Sou

rce

s: f

t.c

om

,


Hig

h G

rade

Bon

dsH

igh

Gra

de B

onds

Sou

rce

s: f

t.c

om

,


Mor

e B

onds

Mor

e B

onds So

urc

es:

ft.

co

m,


US

Gov

ernm

ent B

ond

Mar

ket

US

Gov

ernm

ent B

ond

Mar

ket

Gov

ernm

ents

Gov

ernm

ents

Tre

asur

ies

Tre

asur

ies

Age

ncie

s,

Mor

tgag

e-ba

cked

S

ecur

ities

Age

ncie

s,

Mor

tgag

e-ba

cked

S

ecur

ities


US

U

S T

reas

urys

Tre

asur

ysO

utst

andi

ngO

utst

andi

ng

$0

$500

$1,0

00

$1,5

00

$2,0

00

$2,5

00

Bill

s N

otes

Bon

dsIn

dexe

dD

ata

: D

ec

. 200

4,

US$ b

illio

ns

Sou

rce

: b

on

dm

ark

ets

.co

m


Rat

es: U

SA

Rat

es: U

SA

Sou

rce

: b

on

dso

nlin

e.c

om


Tre

asur

ysT

reas

urys

Rat

e6

Mat

urity

, Mo/

Yr

De

c 97

Bid

Ask

ed9

9:2

9 9

9:3

1A

sk Y

ld.

6.0

1

Tre

asu

ry N

otes

and

Bon

dsa

s qu

oted

in th

e W

all S

tree

t Jou

rnal

�U

S G

ov

ern

me

nt

bo

nd

s a

re q

uo

ted

in

32

nd

s

�Y

ield

is s

em

i-a

nn

ua

l yie

ld t

o m

atu

rity


Tre

asur

ies

and

Str

ips

Tre

asur

ies

and

Str

ips

Mat

urity

, Mo/

Yr

Aug

05

Whe

n th

e si

ngle

cash

flo

w is

pai

d

Typ

eci

Mea

ns "

coup

on in

tere

st"

Bid

Ask

ed51

:21

51:2

6%

of 1

00P

rice

quot

atio

ns

Ask

Yld

.6.

65T

he y

ield

to m

atur

ityat

whi

ch P

V =

pri

ce

Tre

asur

y S

trip

sas

quo

ted

in th

e W

all S

tree

t Jou

rnal

�A

go

od

wa

y t

o v

alu

e a

Tre

asu

ry b

on

d,

or

an

y

oth

er

bo

nd

, is

to

se

e w

ha

t it w

ou

ld c

ost

to

c

on

stru

ct

a s

imila

r se

t o

f c

ash

flo

ws

�Fo

r e

xam

ple

, o

ne

ca

n c

on

stru

ct

a s

et

of

ca

sh

flo

ws

to m

atc

h t

ho

se o

f a

co

up

on

bo

nd

usi

ng

st

rips

-if

it’s

ch

ea

pe

r, t

he

bo

nd

ma

y b

e

ove

rpric

ed

.


Bon

d Le

goB

ond

Lego

�T

o va

lue

this

bon

d, b

reak

it u

p in

to it

s co

mpo

nent

cas

h flo

ws

-e.

g.

1st c

oupo

n of

(5

3/4)

/2 in

Feb

199

6, a

nd s

o on

...�

The

n us

e ze

ro’s

to s

ee w

hat e

ach

is w

orth

, and

add

the

tota

l.

In g

ener

al, b

reak

ing

up a

sec

urity

into

its

com

pone

nt p

arts

is a

n ex

celle

nt p

ath

to v

alua

tion.

Rat

e6

Mat

urity

, Mo/

Yr

Dec

97

Bid

Ask

ed99

:29

99:3

1A

sk Y

ld.

6.01

A T

reas

ury

Not

eas

quo

ted

in th

e W

all S

tree

t Jo

urn

al M

onda

y, J

uly

24, 1

995


US

Gov

ernm

ent S

pons

ored

Ent

erpr

ises

US

Gov

ernm

ent S

pons

ored

Ent

erpr

ises

�G

over

nmen

t-sp

onso

red

ente

rpris

es (

GS

Es)

are

fina

ncin

g en

titie

s cr

eate

d b

y C

ongr

ess

to fu

nd lo

ans

to c

erta

in g

roup

s of

bor

row

ers

such

as

hom

eow

ners

, far

mer

s an

d st

uden

ts. (

GS

Es

are

also

so

met

imes

ref

erre

d to

as

fede

ral a

genc

ies

or fe

dera

lly s

pons

ored

agen

cies

.)�

Stu

dent

Loa

n M

arke

ting

Ass

ocia

tion

(Sal

lie M

ae),

Fed

eral

Nat

iona

l M

ortg

age

Ass

ocia

tion

(Fan

nie

Mae

) an

d F

eder

al H

ome

Loan

M

ortg

age

Cor

pora

tion

(Fre

ddie

Mac

) ar

e pr

ivat

ely

owne

d co

rpor

atio

ns�

The

Fed

eral

Hom

e Lo

an B

anks

and

the

Fed

eral

Far

m C

redi

t B

anks

are

sys

tem

s co

mpr

isin

g re

gion

al b

anks

. �

All

GS

E d

ebt i

s sp

onso

red

but n

ot g

uara

ntee

d by

the

fede

ral

gove

rnm

ent

�G

over

nmen

t Age

ncie

s su

ch a

s G

over

nmen

t Nat

iona

l Mor

tgag

e A

ssoc

iatio

n (G

inni

eM

ae)

are

divi

sion

s of

the

gove

rnm

ent w

hose

se

curit

ies

are

back

ed b

y th

e fu

ll fa

ith a

nd c

redi

t of t

he U

nite

dS

tate

s.


The

Bon

d M

arke

tT

he B

ond

Mar

ket

Mun

icip

al B

onds

Ass

et-B

acke

d S

ecur

ities

For

eign

Bon

ds

Eur

oyen

Bon

ds, e

tc.

Eur

o$bo

nds

Cor

pora

te B

onds

Gov

ernm

ent B

onds

Priv

ate

Pla

cem

ents


The

Eur

opea

n M

arke

tT

he E

urop

ean

Mar

ket

Source: HSBC Market Update on absnet.net


Ass

etA

sset

-- Bac

ked

Issu

ance

Gro

win

g F

aste

rB

acke

d Is

suan

ce G

row

ing

Fas

ter

Sou

rce

: b

on

dm

ark

ets

.co

m, R

ese

arc

h Q

ua

rte

rly


In th

e U

SA

, Con

sum

er F

inan

ce D

omin

ates

In th

e U

SA

, Con

sum

er F

inan

ce D

omin

ates

Sou

rce

: b

on

dm

ark

ets

.co

m, R

ese

arc

h Q

ua

rte

rly


The

Bon

d M

arke

tT

he B

ond

Mar

ket

Mun

icip

al B

onds

Mor

tgag

e-B

acke

d S

ecur

ities

For

eign

Bon

ds

Eur

oyen

Bon

ds, e

tc.

Eur

o$bo

nds

Cor

pora

te B

onds

US

Tre

asur

y B

onds

Priv

ate

Pla

cem

ents


Inst

rum

ents

and

Mar

kets

Inst

rum

ents

and

Mar

kets

Cor

pora

te B

onds

Cor

pora

te B

onds

Dom

estic

Dom

estic

Inte

rnat

iona

lIn

tern

atio

nal


US

Cor

pora

te B

ond

Mar

ket

US

Cor

pora

te B

ond

Mar

ket So

urc

e:

inve

stin

gin

bo

nd

s.c

om


Cor

pora

te B

onds

Cor

pora

te B

onds

Lega

l Asp

ects

Of C

orpo

rate

Bon

ds�

A B

ond

Inde

ntur

eis

a c

ontr

act b

etw

een

the

borr

owin

g co

rpor

atio

n an

d th

e bo

ndho

lder

s, s

tatin

g th

e co

nditi

ons

unde

r w

hich

a b

ond

has

been

is

sued

�C

omm

on fe

atur

es o

f bon

d in

dent

ures

incl

ude:

�S

inki

ng-F

und

Req

uire

men

ts

�S

ecur

ity In

tere

st�

A T

rust

eeis

a th

ird p

arty

pai

d to

pro

tect

the

bond

hold

ers'

inte

rest


Cor

pora

te B

ond

Yie

lds

Cor

pora

te B

ond

Yie

lds

Sou

rce

: im

f.o

rg, G

lob

al F

ina

nc

ial S

tab

ility

Re

po

rt


Pro

visi

ons

of B

onds

Pro

visi

ons

of B

onds

�S

ecur

ed o

r un

secu

red

�C

all p

rovi

sion

�C

onve

rtib

le p

rovi

sion

�P

ut p

rovi

sion

(pu

tabl

ebo

nds)

�F

loat

ing

rate

bon

ds�

Sin

king

fund

s


Pro

tect

ion

Aga

inst

Def

ault

Pro

tect

ion

Aga

inst

Def

ault

�S

inki

ng fu

nds

�S

ubor

dina

tion

of fu

ture

deb

t�

Div

iden

d re

stric

tions

�C

olla

tera

l


Sec

ured

or

Uns

ecur

ed?

Sec

ured

or

Uns

ecur

ed?

�D

eben

ture

bon

ds

Mos

t cor

pora

te b

onds

are

deb

entu

res—

that

is, u

nsec

ured

de

bt o

blig

atio

ns b

acke

d on

ly b

y th

e is

suer

’s g

ener

al c

redi

t and

the

capa

city

of i

ts

cash

flow

to r

epay

inte

rest

and

prin

cipa

l. �

Mor

tgag

e bo

nds

The

se a

re b

onds

for

whi

ch r

eal e

stat

e or

oth

er p

hysi

cal

prop

erty

has

bee

n pl

edge

d as

col

late

ral.

The

y ar

e m

ostly

issu

ed b

y pu

blic

ut

ilitie

s. D

iffer

ent m

ortg

age

bond

s re

flect

the

prio

rity

of th

e lie

n, o

r le

gal c

laim

, on

e ha

s ag

ains

t the

spe

cifie

d pr

oper

ty. A

ny in

vest

or in

mor

tgag

ebo

nds

shou

ld

find

out h

ow m

uch

othe

r de

bt o

f the

issu

er is

sec

ured

by

the

sam

e co

llate

ral a

nd

whe

ther

the

lien

supp

ortin

g th

at o

ther

deb

t is

equa

l or

prio

r to

the

bond

’s li

en.

�C

olla

tera

l tru

st b

onds

A

cor

pora

tion

may

dep

osit

stoc

ks, b

onds

and

oth

er

secu

ritie

s w

ith a

trus

tee

to b

ack

its b

onds

. The

col

late

ral m

usth

ave

a m

arke

t va

lue

at th

e tim

e of

issu

ance

at l

east

equ

al to

the

valu

e of

the

bond

s.�

Equ

ipm

ent t

rust

cer

tific

ates

R

ailro

ads

and

airli

nes

have

issu

ed th

is ty

pe o

f bo

nd a

s a

way

to p

ay fo

r ne

w e

quip

men

t at r

elat

ivel

y lo

w in

tere

st r

ates

. The

title

to

the

equi

pmen

t is

held

by

a tr

uste

e un

til th

e lo

an is

pai

d of

f, an

d th

e in

vest

ors

who

buy

the

cert

ifica

tes

usua

lly h

ave

a fir

st c

laim

on

the

equi

pmen

t.�

Sub

ordi

nate

d de

bent

ures

D

ebt t

hat i

s su

bord

inat

ed, o

r ju

nior

, has

a p

riorit

y lo

wer

than

that

of o

ther

deb

t in

term

s of

pay

men

t (bu

t lik

e al

l bon

ds, i

t ran

ks

ahea

d of

sto

ck).

Onl

y af

ter

secu

red

bond

s an

d de

bent

ures

are

pai

d of

f can

ho

lder

s of

sub

ordi

nate

d de

bent

ures

be

paid

. �

Gua

rant

eed

bond

s A

noth

er fo

rm o

f sec

urity

is a

gua

rant

ee o

f one

cor

pora

tion’

s bo

nds

by a

noth

er c

orpo

ratio

n. F

or e

xam

ple,

bon

ds is

sued

by

a su

bsid

iary

may

be

gua

rant

eed

by th

e pa

rent

cor

pora

tion.

Gua

rant

eed

bond

s be

com

e, in

effe

ct,

debe

ntur

es o

f the

gua

rant

eein

g co

rpor

atio

n.So

urc

e:

inve

stin

gin

bo

nd

s.c

om

Dr.

Ian

Gid

dy

New

Yor

k U

nive

rsity

Bon

d P

ricin

g an

d D

urat

ion

NIB

Cap

ital


Mon

ey M

arke

t Ins

trum

ents

Mon

ey M

arke

t Ins

trum

ents

�T

reas

ury

bills

�C

ertif

icat

es o

f dep

osit

�C

omm

erci

al P

aper

�B

anke

rs A

ccep

tanc

es�

Eur

odol

lars

�R

epur

chas

e A

gree

men

ts (

RP

s) a

nd R

ever

se R

Ps

�F

eder

al F

unds


Bon

d F

unda

men

tals

Bon

d F

unda

men

tals

Som

e bo

nd ja

rgon

:�

Bill

s, n

otes

and

bon

ds

�P

ar v

alue

�C

oupo

n in

tere

st r

ate

�B

ond

pric

es a

nd “

quot

es”

�C

urre

nt y

ield

, yie

ld to

mat

urity

, yie

ld to

cal

l�

Dur

atio

n an

d co

nvex

ity

�A

nd m

any

mor

e: s

ee g

loss

ary


Bon

d P

ricin

gB

ond

Pric

ing

�Se

llin

g a

t a

dis

co

un

tis

wh

en

a b

on

d s

ells

fo

r le

ss t

ha

n

its

pa

r va

lue

(i.e

., t

he

qu

ote

is <

100)

�Se

llin

g a

t p

rem

ium

is w

he

n a

bo

nd

se

lls f

or

mo

re

tha

n it

s p

ar

va

lue

(i.e

., t

he

qu

ote

is >

100)

10

0

9%P

ric

e o

f a

9

% b

on

d


Pre

sent

Val

ues:

Rem

inde

rP

rese

nt V

alue

s: R

emin

der

Sin

gle

amou

nt:

the

amou

nt ti

mes

the

pres

ent v

alue

of i

nter

est

fact

or, o

r P

VIF

k,n

:

Ann

uity

:th

e pe

riodi

c pa

ymen

t tim

es th

epr

esen

t val

ue o

f an

nuity

fact

or, o

r P

VIF

Ak,

n:

PV

AP

MTx

PV

IFA

PM

Txk

kk

nk

n

n

,,

/()

==

−+

11

1

PV

FV

xPV

IFF

Vx

kk

nk

nn

,,

()

==

+1

1


Pre

sent

Val

ue O

f A P

erpe

tuity

Pre

sent

Val

ue O

f A P

erpe

tuity

A p

erp

etu

ity is

an

an

nu

ity t

ha

t g

oe

s o

n

fore

ve

r...

an

d (

1/k

) is

th

e p

rese

nt

va

lue

inte

rest

fa

cto

r

for

a p

erp

etu

ity,

PV

IFA

1 kk

,∞=

PV

PM

Tk

∞=


Bas

ic B

ond

Pric

ing

Bas

ic B

ond

Pric

ing

Tim

e

$1

,00

0

?$

10

0$

10

0$

10

0$

10

0

INTE

REST

PR

INC

IPA

L

The

fo

rmu

la f

or

a b

on

d’s

pric

e is

BI k

I kM

kn

01

21

11

=+

++

++

+(

)(

)..

.(

)


Bas

ic B

ond

Val

uatio

nB

asic

Bon

d V

alua

tion

WH

ER

E:

Bo

= v

alue

of t

he b

ond

at ti

me

zero

I=

ann

ual b

ond

inte

rest

in d

olla

rs (

inte

rest

pay

men

t)M

= p

ar v

alue

of t

he b

ond

kd=

req

uire

d ra

te o

f ret

urn

n=

num

ber

of y

ears

to m

atur

ity

BIx

PV

IFA

Mx

PV

IF

BI k

Mk

kn

n

tn

tn

0

01

11

=+

=+

++

=∑

()

()

()

()

,


Bon

d P

ricin

g E

xam

ple

Bon

d P

ricin

g E

xam

ple

A $

1,00

0 pa

r va

lue

US

Tre

asur

y bo

nd m

atur

es in

20

year

s an

d ha

s a

9%

coup

on in

tere

st r

ate.

If a

n in

vest

or's

req

uire

d ra

te o

f ret

urn

is 1

0%, w

hat i

s th

e va

lue

of th

e bo

nd?

Wha

t We

Kno

w:

M=

$1,

000;

I =

.09

x $1

,000

= $

90; n

= 2

0; k

d=

10%

Bo

= $

90 x

(P

VIF

A10

%,

20)

+ 1

,000

x (

PV

IF10

%,

20)

= $

90 x

(8.

514)

+ $

1,00

0 x

($14

9)

= $

766.

16 +

$14

9 =

$91

5.26

T

hus,

the

mos

t an

inve

stor

with

a 1

0% r

equi

red

retu

rn w

ould

pay

for

this

bon

d is

$91

5.26

, or

a qu

ote

of a

ppro

xim

atel

y 91

½.


Sem

iann

ual I

nter

est a

nd B

ond

Val

ues

Sem

iann

ual I

nter

est a

nd B

ond

Val

ues

Sin

ce m

ost b

onds

pay

inte

rest

eve

ry s

ix m

onth

s, it

in

crea

ses

the

pres

ent v

alue

of t

he c

ash

flow

s an

d, th

us,

the

valu

e of

the

bond

.A

djus

t the

val

uatio

n fo

rmul

a as

follo

ws:

()

()

BP

VIF

AM

PV

IFk

nk

nd

d0

22

22

1 2=

+/

,/

,


Val

ue o

f a S

emia

nnua

l Bon

dV

alue

of a

Sem

iann

ual B

ond

A $

1,00

0 pa

r bo

nd w

ith a

15%

cou

pon

and

15 y

ears

to m

atur

ity a

ndse

mia

nnua

l int

eres

t pay

men

ts is

bei

ng c

onsi

dere

d by

an

inve

stor

with

a

10%

req

uire

d re

turn

. H

ow m

uch

shou

ld h

e be

will

ing

to p

ay?

Bo

= $

150/

2 x

PV

IFA

10/

2, 2

X15

+ $

1,00

0 x

PV

IF 1

0/2

,2X

15

= $

75 x

(P

VIF

A5%

,30)

x

$1,0

00 x

(P

VIF

5%,3

0)

= $

75 (

15.3

73)

+ $

1,00

0 (.

231)

= $

1,38

3.98


Cur

rent

Yie

ldC

urre

nt Y

ield

Giv

en a

$1,

000

par

valu

e bo

nd w

ith a

10%

cou

pon

rate

, cu

rren

tly q

uote

d at

96,

the

curr

ent y

ield

is

.10

x $1

,000

$100

.96

x $1

,000

$960

=

= 1

0.42

%


Yie

ld H

as T

hree

Sou

rces

of R

etur

nY

ield

Has

Thr

ee S

ourc

es o

f Ret

urn

�C

ou

po

n

�C

ap

ita

l ga

in (

or

loss

), if

th

e p

rice

is n

ot

pa

r

�R

ein

ve

stm

en

t

To a

sse

ss b

on

ds,

va

lua

tio

n is

be

tte

r th

an

yie

ld

0102030405060708090100

Jul-

94Ju

l-95

Jul-

96Ju

l-97

A 1

0%

BO

ND

PR

ICED

AT

94


The

Con

cept

of R

etur

nT

he C

once

pt o

f Ret

urn

�R

etur

n is

the

rate

that

you

ear

n on

you

r in

vest

men

t�

One

mea

sure

: Int

eres

t rat

e (o

r co

upon

) on

a

bond

, or

divi

dend

on

a st

ock

(10%

)�

Ano

ther

: cur

rent

yie

ld (I

nter

est o

r di

vide

nd

divi

ded

by p

rice)

Exa

mpl

e: 1

0%/9

4=10

.64%

�A

third

: rea

lint

eres

t rat

e (s

ubtr

act i

nfla

tion)

0102030405060708090100

Jul-

94Ju

l-95

Jul-

96Ju

l-97

A 1

0%

BO

ND

PR

ICED

AT

94


The

Con

cept

of R

etur

nT

he C

once

pt o

f Ret

urn

�T

otal

ret

urn:

take

into

acc

ount

bo

th c

oupo

ns a

nd c

apita

l gai

n

�In

the

illus

trat

ion:

�10

% c

oupo

n

�6%

cap

ital g

ain

(abo

ut 2

%

per

annu

m)

�T

otal

ret

urn

appr

ox.

6%+

2%=

10%

0102030405060708090100

Jul-

94Ju

l-95

Jul-

96Ju

l-97

A 1

0%

BO

ND

PR

ICED

AT

94


The

Yie

ldT

he Y

ield

�Y

ield

to m

atur

ity c

ombi

nes

coup

ons

and

capi

tal g

ains

-al

l cas

h flo

ws.

�T

he y

ield

to m

atur

ity o

n an

y bo

nd, i

s th

e ra

te th

at w

ill

mak

e th

e pr

esen

t val

ue o

f the

cas

h flo

ws

from

the

inve

stm

ent e

qual

to th

e pr

ice

of th

e in

vest

men

t.


Pric

es a

nd Y

ield

s in

the

Wal

l Str

eet J

ourn

alP

rices

and

Yie

lds

in th

e W

all S

tree

t Jou

rnal

Rat

e M

at.

Mo/

yr

Bid

A

sked

C

hg

Ask

Y

ld

5 1/

8 5 ...

7

7/8

8 1/

2 ...

7

1/8

6 1/

4

May

04n

Ju

n 04

n F

eb 0

5-00

F

eb 1

0n

Feb

33

Aug

33

100:

01

100:

04

101:

14

107:

11

95:0

6 85

:21

100:

03

100:

06

101:

16

107:

13

95:0

8 85

:23

...

+1

+1

+7

+16

+14

2.44

3.

35

5.71

6.

92

7.53

7.

46

Mon

day,

May

16,

200

4


Yie

ld T

o M

atur

ity (

YT

M)

Yie

ld T

o M

atur

ity (

YT

M)

�Y

TM

is th

e ra

te o

f ret

urn

inve

stor

s ea

rn if

the

y bu

y a

bond

at a

sp

ecifi

c pr

ice

and

hold

it u

ntil

mat

urity

�Y

TM

is a

lso

the

disc

ount

rat

e th

at c

ause

s th

e bo

nd’s

cur

rent

pric

e to

ju

st e

qual

the

pres

ent v

alue

of i

ts in

tere

st p

aym

ents

and

par

val

ue.

�F

ind

ysu

ch th

at L

HS

=R

HS

:

PC

yC

yM

yn

01

21

11

=+

++

++

+(

)(

)..

.(

)


The

Yie

ld C

urve

The

Yie

ld C

urve

bond

sonl

ine.

com


Yie

ld C

urve

sY

ield

Cur

ves

Yie

lds

Mat

urit

y

Upw

ard

Upw

ard

Slop

ing

Slop

ing

Dow

nwar

d D

ownw

ard

Slop

ing

Slop

ing


The

orie

s of

Ter

m S

truc

ture

The

orie

s of

Ter

m S

truc

ture

�E

xpec

tatio

ns�

Liqu

idity

Pre

fere

nce

�U

pwar

d bi

as o

ver

expe

ctat

ions

�M

arke

t Seg

men

tatio

n �

Pre

ferr

ed H

abita

t


Yie

ld H

as P

robl

ems

Yie

ld H

as P

robl

ems

�R

einv

estm

ent a

ssum

ptio

n: Y

TM

ass

umes

we

rein

vest

at

the

sam

e yi

eld.

�C

oupo

n ef

fect

: diff

eren

t bon

ds w

ith th

e sa

me

mat

urity

, al

l fai

rly p

riced

, hav

e di

ffere

nt y

ield

s.�

Cal

labl

e bo

nds

have

no

defin

ed m

atur

ity.


Yie

ld o

f a Z

ero

Yie

ld o

f a Z

ero

�Z

ero-

coup

on b

onds

sim

ply

pay

the

prin

cipa

l at m

atur

ity,

no in

tere

st, s

o fin

d k

such

that

:

�E

xam

ple:

10-

year

US

Tre

asur

y ze

ro w

ith fa

ce v

alue

$1

,000

pric

ed a

t $39

9.85

: k=

9.60

%

BM

kn

01

=+

()


Bet

ter

Bon

d P

ricin

gB

ette

r B

ond

Pric

ing

The

met

hod

used

pre

viou

sly

disc

ount

s al

l the

bon

d's

cash

flow

s at

a

sing

le r

ate,

the

yiel

d to

mat

urity

. B

ut a

s th

e yi

eld

curv

e sh

ows,

diff

eren

t yie

lds

appl

y to

diff

eren

t m

atur

ities

. The

bes

t wa

y to

look

at t

he y

ield

for

a pa

rtic

ular

mat

urity

is

to fi

nd o

ut th

e yi

eld

on a

zer

o-co

upon

bon

d fo

r th

at m

atur

ity.

The

n w

e ca

n fin

d th

e P

V o

f eac

h ca

sh fl

ow (

coup

ons

& p

rinci

pal)

by

disc

ount

ing

each

cas

h flo

w a

t the

cor

resp

ondi

ng z

ero-

coup

on r

ate.

(O

r, e

quiv

alen

tly, b

y m

ultip

lyin

g b

y th

e co

rres

pond

ing

disc

ount

fa

ctor

.)


Bet

ter

Bon

d P

ricin

g B

ette

r B

ond

Pric

ing

So

we

need

to fi

nd o

ut th

e z'

s: th

e ze

ro-c

oupo

n bo

nd

yiel

ds. T

here

are

two

way

s of

doi

ng th

is.

Bon

d V

alue

=

1C

(1+

1z1 )

+

2C

(1+

2z2 )

+

3C

(1+

3z3 )

+ +

n

M

(1+

nzn )

•••

Let u

s ca

ll th

e ze

ro-c

oupo

n ra

te fo

r ea

ch m

atur

ity z

t. T

hen

the

valu

e of

a b

ond

shou

ld b

e th

e su

m o

f the

PV

sof

eac

h of

the

cash

flow

s.


The

Zer

o A

ppro

ach

The

Zer

o A

ppro

ach

�U

se z

ero-

coup

on r

ates

to v

alue

eac

h ca

sh fl

ow -

then

ad

d th

em!

�W

here

can

we

get t

he z

’s?

One

pla

ce is

from

the

Tre

asur

y st

rip m

arke

t.

BC z

C zM z n

n0

1

1

2

21

11

=+

++

++

+(

)(

)..

.(

)


Iden

tifyi

ng U

nder

valu

ed S

ecur

ities

Iden

tifyi

ng U

nder

valu

ed S

ecur

ities

Bon

dsB

onds

Spo

tR

ates

Spo

tR

ates “C

orre

ct”

pric

ing

“Cor

rect

”pr

icin

g Com

pare

with

act

ual

Com

pare

with

act

ual


Unu

mU

num

�U

num

is c

onsi

derin

g re

stru

ctur

ing

its p

ortfo

lio fr

om c

oupo

n bo

nds

to z

ero-

coup

on b

onds

. The

y ow

n a

two-

year

mat

urity

US

Tre

asur

y bo

nd w

ith a

co

upon

rat

e of

12%

(pa

id a

nnua

lly).

Bas

ed o

n th

e cu

rren

t mar

ket p

rice,

the

yiel

d to

mat

urity

is 5

.8%

.�

The

yie

ld o

n a

1-ye

ar m

atur

ity z

ero-

coup

on o

ndis

5%

, and

on

a 2-

year

m

atur

ity z

ero-

coup

on b

ond

is 6

%.

�W

hat a

rbitr

age

oppo

rtun

ity is

ava

ilabl

e?�

Wha

t is

the

prof

it?�

Wha

t are

the

risks

, if a

ny?

(bas

ed o

n C

h 14

, pro

b16

)


Unu

mU

num

�B

ased

on

the

YT

M, t

he p

rice

of th

e bo

nd is

:

120

PV

IFA

(5.8

%,2

) +

100

0 P

VIF

(5.8

%,2

) =

$11

13.9

9

�B

ased

on

the

spot

cur

ve, t

he p

rice

of th

e sa

me

bond

is:

120/

(1.0

5) +

112

0/(1

.06)

2=

$11

11.0

8

�T

here

fore

, the

arb

itrag

e st

rate

gy

is to

buy

zer

os w

ith fa

ce v

alue

s of

12

0 an

d 11

20 a

nd r

espe

ctiv

e m

atur

ities

of o

ne a

nd tw

o ye

ars,

and

sim

ulta

neou

sly

sell

coup

on b

onds

. The

pro

fit e

qual

s $2

.91

on e

ach

bond

.

(bas

ed o

n C

h 14

, pro

b16

)


Str

uctu

re o

f the

US

MB

S M

arke

tS

truc

ture

of t

he U

S M

BS

Mar

ket

Mor

tgag

e Lo

anB

ank

(mor

tgag

e or

igin

ator

) m

akes

a w

hole

loan

Anc

illar

y: b

roke

rs, s

ervi

cers

, ins

urer

s

Mor

tgag

e Lo

anB

ank

(mor

tgag

e or

igin

ator

) m

akes

a w

hole

loan

Anc

illar

y: b

roke

rs, s

ervi

cers

, ins

urer

s

Mor

tgag

e P

ass-

Thr

ough

FN

MA

or

GM

AC

(co

ndui

t) p

ools

mor

tgag

e lo

ans

with

sim

ilar

char

acte

ristic

s

Mor

tgag

e P

ass-

Thr

ough

FN

MA

or

GM

AC

(co

ndui

t) p

ools

mor

tgag

e lo

ans

with

sim

ilar

char

acte

ristic

s

CM

O o

r R

EM

ICT

akes

a m

ortg

age

pool

and

mak

es th

e ca

sh fl

ows

mor

e pr

edic

tabl

e by

ass

igni

ngpr

iorit

y of

cla

ims

to th

e ca

sh fl

ows

CM

O o

r R

EM

ICT

akes

a m

ortg

age

pool

and

mak

es th

e ca

sh fl

ows

mor

e pr

edic

tabl

e by

ass

igni

ngpr

iorit

y of

cla

ims

to th

e ca

sh fl

ows

MB

S P

ortfo

lioIn

stitu

tiona

l inv

esto

r ev

alua

tes

risk/

retu

rn

beha

vior

of m

ortg

age-

back

ed s

ecur

ities

thro

ugh

optio

n-ad

just

ed p

rice

and

spre

ad a

naly

sis

MB

S P

ortfo

lioIn

stitu

tiona

l inv

esto

r ev

alua

tes

risk/

retu

rn

beha

vior

of m

ortg

age-

back

ed s

ecur

ities

thro

ugh

optio

n-ad

just

ed p

rice

and

spre

ad a

naly

sis

Mor

tgag

e S

trip

sIn

tere

st-O

nly

and

Prin

cipa

l-Onl

y

Mor

tgag

e S

trip

sIn

tere

st-O

nly

and

Prin

cipa

l-Onl

y


Typ

ical

MB

ST

ypic

al M

BS


Mor

tgag

e P

repa

ymen

tsM

ortg

age

Pre

paym

ents

Com

plex

ity o

f the

opt

ion

-�

Sys

tem

atic

ris

k: e

xerc

ise

of th

e in

tere

st r

ate

optio

n�

Uns

yste

mat

ic r

isk:

re

ason

s un

rela

ted

to

mor

tgag

e in

tere

st r

ates

(e

g de

mog

raph

ic)


The

Neg

ativ

e C

onve

xity

of M

BS

The

Neg

ativ

e C

onve

xity

of M

BS

Sec

uriti

es b

acke

d by

fixe

d-ra

te m

ortg

ages

hav

e "n

egat

ive

conv

exity

." T

his

refe

rs to

the

fact

that

whe

n in

tere

st r

ates

ris

e, th

e M

BS

beh

ave

like

long

-ter

m b

onds

(th

eir

pric

es

fall

stee

ply)

; but

whe

n ra

tes

fall,

thei

r pr

ices

ris

e sl

owly

or

not a

t all.

Pric

e

Yie

ld

Pric

e-yi

eld

curv

e of

20

year

bon

d ca

llabl

e in

3ye

ars

20-y

ear

3-ye

ar

Cal

labl

e bo

nd


Con

vexi

ty o

f C

onve

xity

of

Cal

labl

esC

alla

bles

Mo

rtg

ag

e-b

ac

ked

se

cu

ritie

s a

nd

oth

er

ca

llab

le

bo

nd

s m

ay h

ave

ne

ga

tive

co

nve

xity

wh

ich

c

ush

ion

s a

bo

nd

’s p

rice

ris

e a

nd

ac

ce

lera

tes

its

fall!

PR

ICE

YIE

LD

10

0

10

2


Dur

atio

nD

urat

ion

Dur

atio

n m

easu

res

the

% p

rice

chan

ge fo

r a

give

n ch

ange

in

yie

ld:

PR

ICE

YIE

LD9

%

10

0

The

ste

ep

er

the

lin

e, th

e m

ore

th

e p

rice

fa

lls

for

a g

ive

n r

ise

in

yie

ld


Gre

ater

Dur

atio

n, G

reat

er R

isk

Gre

ater

Dur

atio

n, G

reat

er R

isk

Dur

atio

n is

mea

sure

d as

the

PV

-wei

ghte

d av

erag

e lif

e, s

o lo

w-c

oupo

n bo

nds

have

gre

ater

dur

atio

n

PR

ICE

YIE

LD9

%

10

0

6%

BO

ND

9%

BO

ND

0%

BO

ND


Cal

cula

ting

Dur

atio

n:C

alcu

latin

g D

urat

ion:

Mac

Cau

ley

Mac

Cau

ley

and

Mod

ified

and

Mod

ified

D

tCF

rP

DP

dP P

D

r

MA

C

tt

tn

MO

D

=+

==

=−

+

=∑(

)

%(

)

1

1

1

∆


Bon

d P

rice

Cha

nges

:B

ond

Pric

e C

hang

es:

Act

ual v

s. D

urat

ion

Act

ual v

s. D

urat

ion

-- Bas

edB

ased

The

re’s

an

erro

r in

dur

atio

n-ba

sed

estim

atio

n,

beca

use

dura

tion

is li

near

.

PR

ICE

YIE

LD9

%

10

0A

ctu

al

Du

rati

on

Err

or


Con

vexi

ty:

Con

vexi

ty:

The

Cha

nge

in D

urat

ion

The

Cha

nge

in D

urat

ion

The

per

cent

age

pric

e ch

ange

in a

bon

d ca

n be

app

orix

imat

edus

ing

both

dur

atio

n an

d co

nvex

ity.

PR

ICE

YIE

LD9

%

10

0


Con

vexi

ty fo

rC

onve

xity

for

Diff

eren

t Bon

dsD

iffer

ent B

onds

Pos

itive

con

vexi

ty is

des

irabl

e, b

ecau

se it

cu

shio

ns a

bon

d’s

pric

e fa

ll an

d ac

cele

rate

s its

ris

e.

PR

ICE

YIE

LD9

%

10

0

Bo

nd

A

Bo

nd

A

Du

rati

on

lin

e

Dr.

Ian

Gid

dy

New

Yor

k U

nive

rsity

Cre

dit R

isk

and

Rat

ings

NIB

Cap

ital


Def

ault

Ris

k an

d R

atin

gsD

efau

lt R

isk

and

Rat

ings

�R

atin

g co

mpa

nies

�M

oody

’s In

vest

or

Ser

vice

�S

tand

ard

& P

oor’s

�F

itch

�R

atin

g C

ateg

orie

s�

Inve

stm

ent g

rade

�S

pecu

lativ

e gr

ade


Bon

d C

redi

t Rat

ings

Bon

d C

redi

t Rat

ings

Moo

dy’s

Sta

ndar

d &

Poo

r’sIn

terp

reta

tion

Aaa

Aa

AA

AA

AH

igh-

qual

ity d

ebt i

nstr

umen

ts

A Baa

A BB

BS

tron

g to

ade

quat

e ab

ility

topa

y pr

inci

pal a

nd in

tere

st

Ba

B Caa

Ca

C

BB

B CC

CC

CC

Abi

lity

to p

ay in

tere

st a

ndpr

inci

pal s

pecu

lativ

e

DIn

def

ault


Inve

stm

ent G

rade

or

Spe

cula

tive?

Inve

stm

ent G

rade

or

Spe

cula

tive?


Inte

rpre

tatio

n of

Cre

dit R

atin

gsIn

terp

reta

tion

of C

redi

t Rat

ings

Rat

ing

(Moo

dy’s

) D

escr

iptio

n In

vest

men

t Gra

de

A

aa

Bon

ds w

hich

are

judg

ed to

be

of th

e be

st q

ualit

y. T

hey

carr

y th

e sm

alle

st d

egre

e of

inve

stm

ent r

isk

and

are

gene

rally

refe

rred

to a

s "t

op ra

ted,

" “pr

ime

rate

d” o

r “gi

lt-ed

ged.

” Int

eres

t pay

men

ts a

re

prot

ecte

d by

a la

rge

or a

n ex

cept

iona

lly s

tabl

e m

argi

n an

d pr

inci

pal i

s se

cure

. Whi

le th

e va

rious

pro

tect

ive

elem

ents

are

like

ly to

cha

nge,

su

ch c

hang

es a

s ca

n be

vis

ualiz

ed a

re m

ost u

nlik

ely

to im

pair

the

fund

amen

tally

stro

ng p

ositi

on o

f suc

h is

sues

. A

a B

onds

whi

ch a

re ju

dged

to b

e of

hig

h qu

ality

by

all s

tand

ards

. To

geth

er w

ith th

e A

aa g

roup

they

com

pris

e w

hat a

re g

ener

ally

kno

wn

as h

igh

grad

e bo

nds.

The

y ar

e ra

ted

low

er th

an th

e be

st b

onds

be

caus

e m

argi

ns o

f pro

tect

ion

may

not

be

as la

rge

as in

Aaa

se

curit

ies

or fl

uctu

atio

n of

pro

tect

ive

elem

ents

may

be

of g

reat

er

ampl

itude

or t

here

may

be

othe

r ele

men

ts p

rese

nt w

hich

mak

e th

e lo

ng-te

rm ri

sk a

ppea

r som

ewha

t lar

ger t

han

the

Aaa

sec

uriti

es

A

Bon

ds w

hich

pos

sess

man

y fa

vora

ble

inve

stm

ent a

ttrib

utes

and

are

co

nsid

ered

as

uppe

r-m

ediu

m-g

rade

obl

igat

ions

. Fac

tors

giv

ing

secu

rity

to p

rinci

pal a

nd in

tere

st a

re c

onsi

dere

d ad

equa

te, b

ut

elem

ents

may

be

pres

ent w

hich

sug

gest

a s

usce

ptib

ility

to im

pairm

ent

som

e tim

e in

the

futu

re.

Baa

B

onds

whi

ch a

re c

onsi

dere

d as

med

ium

-gra

de o

blig

atio

ns (i

.e.,

they

ar

e ne

ither

hig

hly

prot

ecte

d no

t poo

rly s

ecur

ed).

Inte

rest

pay

men

ts

and

prin

cipa

l sec

urity

app

ear a

dequ

ate

for t

he p

rese

nt b

ut c

erta

in

prot

ectiv

e el

emen

ts m

ay b

e la

ckin

g or

may

be

char

acte

ristic

ally

un

relia

ble

over

any

gre

at le

ngth

of t

ime.

Suc

h bo

nds

lack

out

stan

ding

in

vest

men

t cha

ract

eris

tics.

S

pecu

lativ

e G

rade

Ba

Bon

ds w

hich

are

judg

ed to

hav

e sp

ecul

ativ

e el

emen

ts; t

heir

futu

re

cann

ot b

e co

nsid

ered

as

wel

l-ass

ured

. Ofte

n th

e pr

otec

tion

of in

tere

st

and

prin

cipa

l pay

men

ts m

ay b

e ve

ry m

oder

ate,

and

ther

eby

not w

ell

safe

guar

ded

durin

g bo

th g

ood

and

bad

times

ove

r the

futu

re.

Unc

erta

inty

of p

ositi

on c

hara

cter

izes

bon

ds in

this

cla

ss.

B

Bon

ds w

hich

gen

eral

ly la

ck c

hara

cter

istic

s of

the

desi

rabl

e in

vest

men

t. A

ssur

ance

of i

nter

est a

nd p

rinci

pal p

aym

ents

and

mai

nten

ance

of

othe

r ter

ms

of th

e co

ntra

ct o

ver a

ny lo

ng p

erio

d of

tim

e m

ay b

e sm

all.

Caa

B

onds

whi

ch a

re o

f poo

r sta

ndin

g. S

uch

issu

es m

ay b

e in

def

ault

or

ther

e m

ay b

e pr

esen

t ele

men

ts o

f dan

ger w

ith re

spec

t to

prin

cipa

l or

inte

rest

. C

a B

onds

whi

ch re

pres

ent o

blig

atio

ns w

hich

are

spe

cula

tive

in a

hig

h de

gree

. Suc

h is

sues

are

ofte

n in

def

ault

or h

ave

othe

r mar

ked

shor

tcom

ings

. C

B

onds

whi

ch a

re th

e lo

wes

t rat

ed c

lass

of b

onds

, and

issu

es s

o ra

ted

can

be re

gard

ed a

s ha

ving

ext

rem

ely

poor

pro

spec

ts o

f eve

r atta

inin

g an

y re

al in

vest

men

t sta

ndin

g.

D

Bon

ds w

hich

are

in d

efau

lt (S

&P a

nd F

itch

ratin

gs).

Sou

rce

: m

oo

dys.

co

m


Def

ault

Mat

rixD

efau

lt M

atrix

Sou

rce:

Fitc

h, “

Ban

k C

LOs”


Fac

tors

Use

d by

Rat

ing

Com

pani

esF

acto

rs U

sed

by R

atin

g C

ompa

nies

�C

over

age

ratio

s�

Leve

rage

rat

ios

�Li

quid

ity r

atio

s�

Pro

fitab

ility

rat

ios

�C

ash

flow

to d

ebt


Rat

ings

and

Spr

eads

Rat

ings

and

Spr

eads

Source: bondsonline.com


The

Bon

d M

arke

tsT

he B

ond

Mar

kets

�M

arke

ts a

nd In

stru

men

ts�

The

Str

uctu

re o

f Rat

es�

Inte

rest

Rat

e R

isk

and

Dur

atio

n�

Cre

dit R

isk,

Rat

ings

and

Cre

dit S

prea

ds

Capital Markets Dr. Ian Giddy New York Universitygiddy.org/sf/nibcapital/nib-bonds.pdfThese are...

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Transcript of Capital Markets Dr. Ian Giddy New York Universitygiddy.org/sf/nibcapital/nib-bonds.pdfThese are...