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Basics of Fixed income
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Fixed income market
By: Kendrick Chua
Outline of discussion
• Definition of fixed income• Pros and cons of investing in fixed income• Different fixed income investments available
in the market• Computing for prices and yield• Exercises
What are fixed income?
An investment that provides fixed periodic payments and the eventual return of principal
Components of a fixed income Components of a fixed income
Advantages of investing in fixed income
Disadvantages of investing in fixed income
How do you earn from a fixed income?
Interest income from periodic payments Capital appreciation
How do you earn from fixed income?
Long term negotiable certificate of deposit
A long term negotiable certificate of time deposit indicating an amount of a bank’s indebtedness with a designated maturity
Preferred shares
Company shares that have higher claim than common stocks and typically pay a fixed dividend.
2011 8%
Special deposit accounts
Short-term liability offered by the BSP with tenors ranging from several days to two months
Current interest rate stands at 2.0% as of December 2013
Bonds
A debt instrument that promises to pay a specified sum of money on a specified date
It’s nothing more than a glorified “utang”.
Bonds according to issuer:
Foreign currency-denominated bonds
What are government securities?Evidence of indebtedness issued by the National Government and are free from default
What are corporate bonds?
Bond yieldYield is a figure that shows the return you get on a bond.
Example 1: How much will a bond with a par value of P1,000 and coupon rate of 8% pay an investor?
P80.00(P1,000 par value x 8%)
P80.00(P1,000 par value x 8%)
Coupon amountPrice
A debt instrument that does not pay interest but is traded at a discount, with the face value repaid at the time of maturity
Zero coupon bond
Bond prices move inversely to interest rates
Bond valuation
Example 2: What is the current yield if the bond price goes down to P980?
8.16%(P80/P980)
8.16%(P80/P980)
Example 3: What is the current yield if the bond price goes up to P1,020?
7.84%(P80/P1,020)
7.84%(P80/P1,020)
Yield to maturityAn attempt to measure the compounded rate of return on a bond investment if it were held to maturity.
Example 2: If a P1,000 bond with a 10.0% coupon rate was selling for 92 and matures in 10 years, what is the yield to maturity?
Coupon = P100 (10% X P1,000)Annualized gain = P11.25 ([P1,000 maturity value – P920 current value]/ 10 yearsEstimated average value of investment = P960 ([P1,000+920/2])
P108 = 11.25% P960
What is a yield curve?
Gives an idea of the future interest rate change and economic activity
Shows the correlation between interest rate and the time of maturity
Yields rise as the maturity lengthens
Normal yield curve
Long term yields fall below short term yields
Inverted yield curve
Short and long term yields are equal
Flat yield
Exercise 1: How much will a bond holder receive every quarter if he invests P1M in XYZ bond that has a coupon rate of 8%.
P20,000
Exercise 2: A P1,000 bond that has a coupon rate of 7% sells in the market for P1,100. What is its yield?
6.36%
Exercise 3: A P1,000 bond that has a coupon rate of 12% sells in the market for P975 What is its yield?
12.31%
Exercise 4: The bank is offering you two bonds to invest in. One has a maturity of 15 years and a coupon rate of 6.5%. The other matures in 10 years and has a coupon rate of 5.5%. The first bond sells for P1,100 and the second bond sells for P975. Which is the better deal?
Bond B = 5.82%