Reading 52: Fixed-Income Bond Valuation: Prices and Yields

Book 3: Fixed Income

Yield-To-Maturity

the market discount rate appropriate for discounting a bond’s cash flows

When the Coupon Rate > YTM, does a bond trade at a discount or a premium?

premium

When the Coupon Rate < YTM, does a bond trade at a discount or a premium?

discount

Convexity

a 1% increase in YTM decreases a bond’s value by a given amount

a 2% increase in YTM will decrease the bond’s value by a greater magnitude

For a semiannual coupon, how do you find the YTM?

multiply the I/Y by 2

Accrued Interest

the proportion of coupon payments owed to the seller

Actual/Actual Convention

the actual number of days between coupon payments and the actual number of days between the last coupon date and the settlement date

30/360 Convention

assumes each month is 30 days and every year has 360 days

Who uses the Actual/Actual Convention? 30/360 Convention?

Actual ==> government

30/360 ==> corporations

Are bond prices quoted with or without accrued interest?

without or else every day a bond’s price would go up and then fall dramatically on the day of the coupon

Flat Price

the price of the bond

Full Price

sum of the flat price and the accrued interest

A decrease in YTM will _______ price.

increase

Which is more sensitive to changes in YTM—lower coupon or higher coupon?

lower coupon

When YTM increases, how is value effected relative to if YTM decreased?

When yields fall, a bond’s price rises more than it would fall if yields rose by the same amount

Constant-Yield Price Trajectory

the price of a bond will converge to par value as maturity approaches

Matrix Pricing

method of estimating YTM or price that are currently not traded or infrequently used

What does Matrix Pricing work?

use the YTMs of bonds of similar credit quality and maturity and coupon