Fixed Income Securities

Formulae Sheet. Class Test #1. Feb 28th, 2011

Interest Rates
Simple compounding A 1+ R m
nm

where m is the compounding frequency per year, and n is the number of year to compound the principal A: Continuous compounding AeR(0;T )T

Bond price (discounted cash method) ow

P V (Bond) = = = PT PT PT
t=1 t=1 t=1

CFt (1 + Rs (0; t))t CFt exp ( Rc (0; t) t) B(0; t)CFt ; where

CFt is the cash at time t ow B(0; t) is the price of the discounted bond paying $1 at time t Rs (0; t) is the simple compounding spot rates from time 0 to time t Rc (0; t) :::is the continously compounding spot rates from time 0 to time t

Bond price formula

If the bond pays a constant coupon rate c, and y is the discount rate that applies to all maturities. Then the price of a coupon paying bond with maturity T and the face value of F is c F 1 F 1 + P0 = T y (1 + y)T (1 + y)

Forward rates
Simple compounding (1 + R (0; y))y F (0; x; y) = (1 + R (0; x))x
1 y x

where F (0; x; y) is the forward rate agreement that is locked in at date t = 0; to be applied from time x to time y 1

Continuous compounding F (0; x; y) = R (0; y) + (R (0; y) R (0; x)) x y x

Yield to maturity
Yield to maturity for a n maturity coupon paying bond with the cash CFi on each ow year i = 1::n is CF2 CF1 CFn + ; P = 2 + :::::: + 1 + y (1 + y) (1 + y)n where I have assumed simple (annual) compound above. However, if we use continuous-compounding and assume that the cash CFi on each time ow ti is P = CF1 e y t1 + CF2 e y t2 + :::::: + CFn e y tn :

Bond par yield

A par bond is a bond with a coupon identical to its yield to maturity. The bond par yield c (n) is the coupon rate such that a n year maturity xed bond that pays such coupon rate annually is a par bond. Let say if $100 is the bond face value, then s 100 c (n) 100 + 100 c (n) 100 c (n) + = 100: 2 + :::::: + 1 + R(0; 1) (1 + R(0; 2)) (1 + R(0; n))n The bond par yield is thus 1 c(n) = Pn
1 (1+R(0;n))n 1 i=1 (1+R(0;i))i

Forward and Futures price

1 B (0; n) : = Pn i=1 B (0; i)

For an underlying security with the present value B0 ;the fair price for a forward contract to buy/deliver this asset at the future date T is Continuous compounding F0 = B0 eR(0;T )T Simple compounding F0 = B0 (1 + R(0; T ))T