Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS
description
Transcript of Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS
![Page 1: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/1.jpg)
Chapter 9 FIXED INCOME SECURITIES:
VALUATION AND RISKS• Why are bonds viable investment
alternatives?• What are the risks faced by bond
investors?• How bonds are priced?• What are the basic bond pricing
theorems?• How can interest rate risk be measured?• How can credit risk be evaluated?• How are bond risk and required return
related?
![Page 2: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/2.jpg)
Why bonds?
• Income
• Potential for capital gains
• Paper versus real losses
• Diversification
• Tax advantages
![Page 3: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/3.jpg)
Figure 9.1 – Yield on Long-Term Treasury Bonds vs. the Dividend Yield from the S&P500
![Page 4: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/4.jpg)
Risks associated with investing in bonds
• Credit risk• Interest rate risk • Reinvestment risk• Purchasing power risk• Call risk• Liquidity risk• Foreign exchange risk
![Page 5: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/5.jpg)
Bond valuation
• Basics of bond pricing– Identifying the bond’s cash flows
– Bond price is present value of its cash flows
– Semiannual coupons
– Accrued interest
![Page 6: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/6.jpg)
Bond valuation – Cont.
• Yield-to-maturity
• Relationship between coupon rate and yield to maturity
• Current yield
• Yield to call
• Actual return versus yield to maturity
![Page 7: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/7.jpg)
Figure 9.2 - Reinvestment Rate and the Actual Rate of Return for a Bond
![Page 8: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/8.jpg)
Five bond pricing theorems• Bond prices move inversely to changes in
interest rates• Bonds with longer maturities are more price
sensitive• Price sensitivity increases at a decreasing
rate• Bonds with lower coupon rates are more
price sensitive• A price increase caused by a decrease in
interest rates is larger than a price decrease caused by an increase in interest rates of the same magnitude
![Page 9: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/9.jpg)
Figure 9.3 – Bond Price vs. Yield to Maturity
![Page 10: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/10.jpg)
Figure 9.4 – Price Sensitivity and Maturity
![Page 11: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/11.jpg)
Figure 9.5 – Price Sensitivity and Coupon Rate
![Page 12: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/12.jpg)
Figure 9.6 – Price Changes for Increase and Decrease in Yield
![Page 13: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/13.jpg)
Assessing interest rate risk
• What is duration?
• Finding a bond’s duration
• Duration and price sensitivity
• Duration and price changes
![Page 14: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/14.jpg)
Figure 9.7 – Relationship Between Duration and Maturity
![Page 15: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/15.jpg)
Figure 9.8 – Relationship Between Duration and Coupon Rate
![Page 16: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/16.jpg)
Figure 9.9 – Relationship Between Duration and Yield to Maturity
![Page 17: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/17.jpg)
Credit risk
• Bond ratings– Description of bond ratings– Determinants of bond ratings– Bond ratings and default rates– Graham & Dodd on credit risk and bond
selection
![Page 18: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/18.jpg)
Risk and required return for bonds
• General relationship (equation 9.8) r = f (i, ∆p, ir, rr, dr, cr, lr, fxr)
• Bond yields and maturity
• Bond yields and credit risk
![Page 19: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/19.jpg)
Figure 9.10 – Yield Spread Between T-Bonds and T-Bills
![Page 20: Chapter 9 FIXED INCOME SECURITIES: VALUATION AND RISKS](https://reader034.fdocuments.in/reader034/viewer/2022042501/56814ecd550346895dbc6a1d/html5/thumbnails/20.jpg)
Figure 9.11 – Quality Yield Spreads in the U.S. Capital Markets