FNCE 30001 Week 6 Fixed Income Fundamentals

FNCE 30001 Investments FNCE 30001 Investments
Semester 2, 2011
31 August & 2 September 2011 31 August & 2 September 2011
Week 6: Fixed Income Fundamentals
Professor Rob Brown
FNCE 30001 Investments: 6.0
Week 6: Fixed Income Fundamentals Week 6: Fixed Income Fundamentals
Overview of Lecture
1. Fixed Income Securities: What and who?
2. Bond Types
3. Pricing Zero-coupon Bonds 3. c g e o co po o ds
4. Pricing Money Market Securities
5. The Zero Rate Curve 5. The Zero Rate Curve
6. Using the Zero Rate Curve to Price Securities
7 Measuring the Return on Zeros 7. Measuring the Return on Zeros
Readings: Bodie et al, Chapter 14.
1. Fixed Income Securities: What and who?
Fixed Income Securities: What and who? Fixed Income Securities: What and who?
What is a Fixed Income Security?
Four characteristics of a fixed income security (note, bill,
bond, debenture) are:
1. the issuer (debtor, borrower) promises to repay the
i (l d b dh ld ) investor (lender, bondholder)
2. the amount borrowed (principal or price)
3 l i 3. plus interest
4. at a specific point or points in time.
Comparing some US and Australian Terminology
US AUSTRALIA
Treasury bills (28, 91, 182 days) Treasury notes (up to one year) y ( , , y ) y ( p y )
Treasury notes (up to 10 years) Government bonds
G b d (> 10 ) G b d Government bonds (> 10 years) Government bonds
Commercial paper (up to 270 days) Bills of exchange (30, 90, 180 days)
Corporate bonds, Debentures Corporate bonds, Debentures
Wh I l d? Whos Involved?
Issuers: Commonwealth government, state governments,
financial intermediaries corporations financial intermediaries, corporations.
Note: semi-government bonds are issued by the
associated state government. g
Investors: Financial intermediaries, investment funds,
superannuation funds, corporations, individuals.
Others:
Credit Rating Agencies: S&P, Moodys, Fitch.
Regulators: ASIC, APRA, ATO, RBA
Industry bodies: AFMA, ABA
600.0
Debt Securities on Issue in Australia (A$b)
400.0
500.0
200 0
300.0
Short-term non-govt
Long-term non-govt
Short-term govt
100.0
200.0
Long-term govt
0.0
S
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2. Bond Types
Bond Types Bond Types
1. Fixed-coupon Bonds
The fixed-coupon bond is the classic bond type.
A fixed-coupon bond makes two kinds of payments:
Par value (face value): The payment the bond holder
receives when the bond matures.
Interest (coupon payment): Additional pre-specified
d b f ( d ) h i d payments made before (and on) the maturity date at pre-
specified intervals (eg yearly, half-yearly, quarterly).
- U ll d i l l % t - Usually expressed as a simple annual % rate.
Why the term coupon payment?
Example: Commonwealth Govt bond 6.50% May 2013 p y
Par value is taken to be $100.
Coupon interest is paid twice per annum on 15 May and 15 November each year.
Each half-yearly coupon is x 6.50% x $100 = $3.25
If you bought this bond on, say, 31 August 2011, you would get these cash flows:
On 15 November 2011: $3 25 On 15 November 2011: $3.25
On 15 May 2012: $3.25
On 15 November 2012: $3.25
On 15 May 2013: $3.25
Also on 15 May 2013: $100.00
Example: Commonwealth Govt bond 6.50% May 2013 p y
(contd.)
Of course, in practice you cant buy as little as a $100 bond.
Suppose you bought bonds with a par value of $10 million.
If you bought this bond on 31 August 2011, you would get these
cash flows:
On 15 November 2011: $325,000
On 15 May 2012: $325,000
On 15 November 2012: $325,000
On 15 May 2013: $325,000
Also on 15 May 2013: $10,000,000
2. Capital Indexed Bonds . Cap a de ed o ds
A capital indexed bond is the same as a fixed-coupon bond
except that the par value and coupon payments are stated in p p p p y
real (ie after-inflation) terms.
That is, a CPI adjustment is made at each coupon date so that
the investor earns the stated real interest rate.
Example: The Australian government has issued capital indexed
bonds.
3. Floating Rate Bonds (Notes) 3. oa g a e o ds (No es)
Like the fixed-coupon bond, a floating rate bond pays regular
coupons and the par value at maturity. p p y
But the coupon rate is not fixed.
Typically, each coupon payment is linked to a short-term yp y, p p y
interest rate current at the beginning of the coupon period.
Therefore:
If interest rates rise during the life of the bond, the coupon
payments also rise.
But if interest rates fall during the life of the bond then the
coupon payments also fall.
4. Convertible Bonds (Notes) ( )
Like a standard bond (eg a fixed-coupon bond) plus the
investor has an option to convert to shares at maturity.
For example, a convertible note may have a par value of $100
and at maturity the investor can choose to get:
Th $100 in h r The $100 in cash or
20 shares in the borrower
Clearly the investor chooses the $100 if the share price on the Clearly, the investor chooses the $100 if the share price on the
maturity date is less than $5 per share.
A convertible bond must be worth more than an otherwise
equivalent straight bond.
This may show up as a lower coupon interest rate.
5. Callable Bonds 5. Ca ab e o ds
Like a standard bond (eg a fixed-coupon bond) plus the
borrower has an option to repay the bonds early. p p y y
This option may not apply until (eg) the last 2 years of the
bonds life.
The borrower may choose to repay early if interest rates have
fallen since the money was borrowed.
A callable bond must be worth less than an otherwise
equivalent straight bond.
This may show up as a higher coupon interest rate.
6. Domestic vs International Bonds
Domestic
eg a US company issues a USD bond in the US.
International
Foreign bond
- eg an Australian company issues a USD bond in the US
(known as a Yankee bond)
Eurobond
- eg a company issues a USD bond in the UK.
These bonds may be coupon-paying, convertible, callable etc.
7 Z B d (I ) 7. Zero-coupon Bonds (Instruments)
a.k.a. Pure Discount Securities
Only one cash flow (the par value), which occurs on the
maturity date.
E pl M n short term debt se rities s h s Examples: Many short-term debt securities such as:
Treasury Notes (Australia)
Treasury Bills (US) Treasury Bills (US)
commercial bills.
In principle, there could also be long-term zero-coupon bonds In principle, there could also be long term zero coupon bonds
but in practice there are few.
But note: the zero coupon bond is an important building
block for theory and practice.
3. Pricing Zero-coupon Bonds
Pricing Zero coupon Bonds Pricing Zero-coupon Bonds
I d i i h i f b d ( f In determining the price of a zero-coupon bond (a zero for
short), the market takes into account:
The features of the bond: The features of the bond:
o Time to maturity ()
Th d f lt i k f th b ( ) o The default risk of the borrower ()
Tax ()
Li idi i h d k (+) Liquidity in the secondary market (+)
Expected inflation ()
Time value of money: $1 to be received in the future has a lower
value than $1 to be received today.
Th h i l f There are many ways to represent the time value of money:
Prices of zero-coupon bonds.
Z Zero-coupon rates.
Yields-to-maturity.
d Forward rates.
Discount factors.
Notation
Par: Par value or face value or principal.
P
0
: Current (time 0) bond price.
z
0T
: Zero-coupon interest rate (pa) from time 0 to time T.
d
0T
: Discount factor from time 0 to time T.
HPR
0T
: Holding period rate of return (pa) from time 0 to
0T
g p p
time T.
A: Zero rates where there is no default risk
Consider a default-free zero that pays $Par T years from now
(ti 0) (time 0).
Its price is:
Par
( )
=
+
0
0
1
T
T
Par
P
z
where z
0T
is the interest rate that applies per year from time 0 to
time T.
z is called the T year zero coupon rate z
0T
is called the T-year zero coupon rate
Note that zero rates are on a compound interest basis,
regardless of their term, and are quoted per annum.
g , q p
For a given par value, if we know z
0T
we can calculate P
0
.
Example
Calculate the price of a zero with 10 year maturity and par value
$100. The current 10-year zero coupon rate is 7.5% pa; that is,
z = 0 075 p a z
0,10
= 0.075 p.a.
Answer
Par
( )
=
+
0
0
1
$100
T
T
Par
P
z
( )
=
10
$100
1.075
$48 519393
= $48.519393
If we know P
0
we can calculate z
0T
. Rearranging the equation:
| |
=
|
1
1
T
Par
z
Example
=
|
\ .
0
0
1
T
z
P
A 5-year zero with a par value of $1,000,000 is sold for $650,000.
What is the implied 5-year zero rate?
Answer
| |
=
|
\ .
1
0
0
1
T
T
Par
z
P
| |
=
|
\ .
1 5
0,5
$1, 000, 000
1
$650, 000
z
= 8.9977% pa.
Comparative Statics
Recall that the pricing formula is:
( )
=
+
0
0
1
T
T
Par
P
z
The price (P
0
) is related to:
The par value (Par): positively
Todays zero-coupon rate (z
0T
): negatively
The term to maturity (T): negatively
Note that for zeros P is always less than Par Note that for zeros, P
0
is always less than Par.
This is not necessarily true of coupon-paying bonds.
P
0
is negatively related to z
0T
Examples: from previous example:
if z
0,10
= 10% pa, then P
0
= $38.55
if z
0,10
= 8% pa, then P
0
= $46.32 z
0, 0
p
0
P
0
is negatively related to T
Examples: from previous example: Examples: from previous example:
if T = 1, then P
0
= $93.02
if T 15 h P $33 80 if T = 15, then P
0
= $33.80
Less obviously, when the term to maturity (T) is larger, the bond price is more
sensitive to changes in the interest rate: g
Term
(T)
Price if
z
0T
=7.5%pa
Price if
z =8% pa
Change in
price ($)
Change in
price (%) (T) z
0T
7.5% pa
z
0T
=8% pa
price ($) price (%)
$100
$100
1 year $0.4307 0.463%
=
=
0
$100
1.075
$93.0233
P
=
=
0
$100
1.08
$92.5926
P
10 years $2 2001 4 534%
$100
P
$100
P
10 years $2.2001 4.534%
( )
=
=
0
10
$
1.075
$485194
P
( )
=
=
0
10
1.08
$46.3193
P
=$48.5194
$46.3193
B: Zero rates where there is default risk
When there is default risk we need to distinguish between the
promised interest rate and the expected interest rate.
Consider a T-year zero with a face value of Par.
The probability of default is b.
If default occurs, the probability of recovering some of the
d i amount owed is r.
The proportion recovered is and will be received at time
TT.
PPar
x Par
1 b
r
Default
b
Zero
1 r
Promised zero rate (z
0T
): Promised zero rate (z
0T
):
( )
=
+
0
Promised Cash Flow
1
T
P
z
( )
( )
+
=
+
0
1
1
T
T
z
Par
z
( )
+
| |
=
|
\ .
0
1
0
1
1
T
T
T
z
Par
z
P
Of course, this is the same formula as in the default-free case.
|
\ .
0
0
T
z
P
,
Expected 1-year zero rate
( )
*
0T
z
Expected 1 year zero rate
( )
=
0
*
Expected Cash Flow
T
P
( )
0T
z
( )
( )
( )
+
+
=
*
0
*
1
1
T
T
T
z
b Par b r Par
( )
( )
+
(

=
*
0
1
1 1
T
T
T
z
Par b r
( )
( )
+

(

`
*
0
1
*
1
1 1
1
T
T
T
z
Par b r
( )
( )
( )

=
`

)
= =
0
0
*
0 0
1
Of course, if 0 then expected promised .
T
T T
z
P
b z z
( )
( )
Comparative Statics
The expected 1-year zero rate is related to:
( )
*
0T
z
The probability of default (b): negatively
The probability of recovery (r): positively
The proportion expected to be recovered (): positively
Example Example
Suppose Par = $1,000,000; P
0
= $740,000; T = 3; b = 0.005;
r = 0 6 and = 0 4 r = 0.6 and = 0.4.
Then the promised zero rate is:
1 T
| |
=
|
\ .
1
0
0
1
T
T
Par
z
P
| |
=
|
\ .
1 3
$1, 000, 000
1
$740, 000
= 10.558% pa.
Example (contd ) Example (contd.)
The expected zero rate is:
( )

(

1
1 1
T
P b
( )

(

=
`

)
*
0
0
1 3
1 1
1
T
Par b r
z
P
( )

(

=
`

)
1 3
$1, 000, 000 1 0.005 1 0.6 0.4
1
$740, 000
| |
=
|
\ .
1 3
$996, 200
1
$740, 000
= 10.418% pa.
4. Pricing Money Market Securities
Pricing Money Market Securities Pricing Money Market Securities
A: Australian Money Market Securities
In Australia, these securities are priced using simple interest.
Suppose the interest rate for a commercial bill for the next
90 d i 4% Th l i $100 000 90 days is 4% per annum. The par value is $100,000.
What is the price?
The interest rate for the 90-day period is calculated as:
=
90
0.04 0.0098630137
365
So the price is:
365
$100, 000
P =
=
0
$ 00, 000
1.0098630137
$99, 023.33
P
Putting this into a single formula, money market
securities in Australia are priced using:
Par
h i h b f d il i
=
+
0
,
1
365
Par
P
n
s
where n is the number of days until maturity.
s is the simple annual interest rate (yield)
Rearranging the equation, if we are given the price P
0
,
the implied yield s is:
| |
365 P
| |
=
|
\ . 0
365
1
Par
s
P n
B: US Money Market Securities
US money market dealers trade in terms of bank discount
rates, which are defined this way:
| |
=
|
1
n
P Par q =
|
\ .
0
1
360
where means the rate quoted.
P Par q
q
Note there are two differences here:
(1) Th i i d bt ti f ( t (1) The price is expressed as a subtraction from (not a
proportion of) the par value.
(2) It uses a 360 day year instead of a 365 day year
(2) It uses a 360-day year instead of a 365-day year.
Example
A US dealer who agrees on a (quoted) rate of 4% pa for a A US dealer who agrees on a (quoted) rate of 4% pa, for a
term of 90 days, when the par value is $100,000 has agreed to
pay: p y
| |
=
|
\ .
0
1
360
n
P Par q
| |
=
|
\ .
90
$100, 000 1 0.04
360
$100 000 (1 0 01) =
=
$100, 000 (1 0.01)
$99, 000
Example (contd.)
But the yield reported in the US financial press may be But the yield reported in the US financial press may be
calculated the same way as it is in Australia.
Given that the price is $99 000 the implied yield is: Given that the price is $99,000, the implied yield is:
| |
=
|
\ .
365
1
Par
s
P n
\ .
| |
=
|
\ .
0
$100, 000 365
1
$99 000 90
P n
\ .
=
$99, 000 90
4.0965% pa
5. The Zero Rate Curve
The Zero Rate Curve The Zero Rate Curve
f f Definition of the zero rate curve:
Plot of zero coupon rates (vertical axis) against term to maturity
(horizontal axis). ( )
Also called the term structure of zero coupon rates.
Example:
Suppose on 31 August 2010 you saw the following current interest rates
reported in the Australian financial press:
60-day bank bill yield: 5 950% pa 60 day bank bill yield: 5.950% pa
90-day bank bill yield: 6.347% pa
180-day bank bill yield: 6.687% pa
1-year zero-coupon bond: 7.000% pa
2-year zero-coupon bond: 7.100% pa
Pl h
Plot the zero curve.
Stop and THINK!
Zero rates are by definition compound rates.
The bond rates will be quoted on a compound interest basis
but the bill rates will be quoted on a simple interest basis.
So, first we need to convert the bill rates to their compound
interest equivalents.
To do this, we equate the bill price calculated using the simple
interest formula with the bill price calculated using the
compound interest formula compound interest formula.
That is:
Par Par
( )
60 365
0, 60 365
60
1
1 0.0595
365
Par Par
z
=
+
+
which solves to give z
0T
= 6.100% pa.
To show this works, suppose you had to price a bill with a par value of
$100,000. $ ,
Using the simple interest rate of 5.95% pa, we get:
=
0
$100, 000
P =
+
=
0
60
1 0.0595
365
$100, 000
P
Using the compound interest rate of 6.100% pa, we get:
=
1.009780822
$99, 031.39
g p p , g
( )
=
0
60/365
$100, 000
1.06100
P
=
=
$100, 000
1.009780981
$99, 031.38
Using the same approach we find:
the zero rate for 90 days = 6 500% pa the zero rate for 90 days = 6.500% pa
the zero rate for 180 days = 6.800% pa
The full set of zero rates is therefore:
60 days: 6.100% pa
90 days: 6.500% pa
180 days: 6.800% pa
1 year: 7.000% pa
2 years: 7 100% pa 2 years: 7.100% pa
71
Zero
7.0
7.1
Zero
Rate
%pa
6.8
6.5
6.1
Term
2 years 1 year 180
days
90
days
60
days
Term days
The previous example produced an upward-sloping zero
curve.
Al h h f ll l d Although often seen, not all zero curves slope upwards.
For example, zero curves can be (and have been) downward
sloping and flat sloping and flat.
We will study the term structure of zero rates in more detail
in Week 10 in Week 10.
6. Using the Zero Rate Curve to
Price Securities Price Securities
Using the Zero Rate Curve Using the Zero Rate Curve
Once we have todays zero rate curve it is very easy to
calculate the present value (price) of any single future cash
flow flow
or any set of future cash flows.
Example Example
Consider the following (rather odd) security.
It pr mi t p th r It promises to pay the owner:
$300 after 180 days and
$400 f 1 d $400 after 1 year and
$650 after 2 years.
Example (contd.)
The current zero rate curve is:
60 days: 6.100% pa
90 days: 6.500% pa
180 days: 6.800% pa
1 year: 7.000% pa
2 years: 7.100% pa
How much is this security worth today?
Answer to Example
Because we have the zero rate curve, we can value this
i il security very easily:
( ) ( )
= + +
0
180 365 2
$300 $400 $650
1 07
1 068 1 071
P
( ) ( )
= + +
=
1.07
1.068 1.071
$290.4232 $373.8318 $566.6755
$1230.93
This procedure is called pricing off the zero curve.
$ 30.93
Valuing a Fixed-Coupon Bond
A more likely use of the zero rate curve is to value a fixed-
b d coupon bond.
A fixed-coupon bond is like a portfolio of zeros.
If k h i ( d h h ) f h If we know the prices (and hence the zero rates) of the
constituent zeros, then pricing a coupon bond is simple:
+ C C C C C P
( ) ( )
( )
( )
+
= + + + + +
+
+ + +
+
0
2 3 1
01
02 03 0
0, 1
...
1
1 1 1
1
T T
T
T
C C C C C Par
P
z
z z z
z
Practical problem: few long-term zeros exist.
S l i hi bl d i h l
where is the coupon amount. C
Solutions to this problem are covered in the next lecture.
Example a p e
Suppose we can observe the current prices of 1-year, 2-year and
3-year zeros with notional par values of $100 each: y p $
1-year zero: $94.117647
2-year zero: $87.794573 y $
3-year zero: $81.916543
Use this information to price a 3-year coupon bond with the Use this information to price a 3 year coupon bond with the
following features:
Par value: $10,000,000 , ,
Coupon rate: 8% pa
Coupon frequency: 1 per year
p q y p y
Answer to Example
Recall that:
| |
1/T
Therefore,
| |
=
|
\ .
1/
0
0
1
T
T
Par
z
P
,
| |
= =
|
\ .
1/1
01
$100
1 6.250% pa
$94.117647
z
\ .
| |
= =
|
\ .
1/2
02
$100
1 6.725% pa
$87.794573
z
| |
= =
|
\ .
1/3
03
$100
1 6.875% pa
$81.916543
z
Answer to Example (contd.)
The coupon, paid annually, is 8% $10,000,000 = $800,000
Hence the bond price is Hence, the bond price is:
( ) ( )
= + +
0
2 3
$800, 000 $800, 000 $10, 800, 000
1 0625
1 06725 1 06875
P
( ) ( )
= + +
=
2 3
1.0625
1.06725 1.06875
$752, 941.18 $702, 356.59 $8, 846, 986.66
$10 302 284 43
This is an example where a coupon bond (unlike a zero) is worth more than its
par (face) value
= $10, 302, 284.43
par (face) value.
When this happens, the bond is said to be trading at a premium.
If a bonds price is less than its par value, the bond is trading at a discount.
d k h b d ll b $ How do we know the bonds price will be $10,302,284.43?
Answer: Because, if it is anything else, then there is an arbitrage opportunity.
For example suppose we owned this bond and someone offered to buy it from For example, suppose we owned this bond and someone offered to buy it from
us for $10,350,000.
Heres what we could do:
1. Sell the bond for $10,350,000 and then
2. Buy zeros as follows:
A 1 year zero with a par value of $800 000 and A 1-year zero with a par value of $800,000 and
A 2-year zero with a par value of $800,000 and
A 3-year zero with a par value of $10,800,000. y p $ , ,
3. Laugh
Clearly, this set of investments replicates those that we would get from
continuing to own the bond continuing to own the bond.
The cost of the strategy is:
=
$800,000
Cost of the 1 year zero = $752 941 18
( )
=
=
2
Cost of the 1-year zero = $752, 941.18
1.0625
$800, 000
Cost of the 2-year zero = $702, 356.59
1 06725 ( )
( )
=
3
1.06725
$10, 800, 000
Cost of the 3-year zero = $8, 846, 986.66
1.06875
These numbers should be familiar to you!
The total cost of the strategy is, of course, $10,302,284.43.
H h h l f f $10 350 000 $10 302 284 43 $47 715 57
( )
Hence, we have cash left over of $10,350,000 $10,302,284.43 = $47,715.57.
Another way to arbitrage is to invest the whole of the $10.350m in zeros such
that we get a higher cash flow on every future coupon date.
7. Measuring the Return on Zeros
Measuring the Return on Zeros Measuring the Return on Zeros
Yield-to-maturity
Yield-to-maturity (or simply yield) is defined as the single
interest rate that equates the price of the bond to the present
value of the future cash flows the bond will generate.
F i ld i h h For zeros, yield is the same as the zero rate.
For coupon-paying bonds, yield is usually close to, but not
equal to the zero rate equal to, the zero rate.
The difference between yield and zero rate will be clearer
when we return to coupon bonds in the next lecture when we return to coupon bonds in the next lecture.
Discount Factors
The price of a zero with a par value of $1 and a term of T is
called the zeros discount factor, denoted d
0T
.
( )
=
+
0
1
1
T
T
d
z
If we know z
0T
we can calculate d
0T
, and vice-versa.
( )
+
0
1
T
z
z
0T 0T
Example 1
Calculate the discount factor for z
01
= 5%.
What is the price if Par is $100?
Answers:
=
1
d
( )
=
+
0
0
1
1
T
T
T
d
z
=
=
1.05
0.9524
= =
0
0.9524 $100 $95.24 P
Example 2
Suppose todays zero rates are:
for 1 year: 8 5% pa for 1 year: 8.5% pa
for 2 years: 9.5% pa
for 3 years: 9.8% pa
What are todays discount factors?
Answers:
( )
= =
01
1
for 1 year: 0.921659 d
( )
( )
= =
01
02
2
y
1.085
1
for 2 years: 0.834011
1.095
d
( )
( )
= =
03
3
1.095
1
for 3 years: 0.755428
1.098
d
The Holding Period Rate of Return (HPR)
As with any other investment (eg shares, property, antique
silverware ,) if a bond is bought for price P
0
and sold X years
later for price P
X
, and there are no other cash flows involved,
then the dollar return over the holding period from time 0 to then the dollar return over the holding period from time 0 to
time X is simply P
X
P
0
.
The rate of return (ex post) from time 0 to time X is just: The rate of return (ex post) from time 0 to time X is just:
0
.
X
P P
P
0
P
N ll ld li hi f Normally we would annualise this rate of return.
The annualised holding period rate of return is:
/ X
| |
= +
|
\ .
1/
0
0
0
1 1
X
X
X
P P
HPR
P
| |
=
|
\ .
1/
0
1
X
X
P
P
Because (usually) P
X
is unknown at time 0, (and anyway X itself
may be unknown) the holding period rate of return is also not
known at time 0.
Hence, the investment is risky
if h i di (d f l ) i k
even if there is no credit (default) risk.
N id h i l (b i ) h Now consider the special (but very important) case where a
default-free zero is bought for P
0
at time 0 and is held until
maturity at time T. y
The rate of return achieved is:
| |
|
1/T
T
P
| |
=
|
\ .
| |
0
0
1/
1
T
T
T
P
HPR
P
| |
=
|
\ .
/
0
1
Par
P
Because Par, P
0
and T are known at time 0, this is a risk-free return.
A d h hi i f ill b And we can say what this certain rate of return will be.
Recall that:
| |
1/T
P
As weve just seen this is also the equation for HPR
| |
=
|
\ .
0
0
1
T
Par
z
P
As we ve just seen, this is also the equation for HPR
0T
.
That is, z
0T
= HPR
0T
.
Suppose we buy a zero and hold it until maturity. Suppose we buy a zero and hold it until maturity.
We are certain to achieve an annualised holding period rate
of return (HPR
0T
) that is equal to the current zero rate (z
0T
).

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