Investment and Portfolio

Management
Lecture 8
Bond Prices and Yields
Chapter 14
Ms. Pham Le Thu Nga

14-2

Bond Characteristics
Face or par value (normally bullet maturity)
Coupon rate (normally fixed)
Zero coupon bond
Floating rate
Inverse floater

Compounding and payments

Accrued Interest: Clean price (quoted) vs. dirty
price (invoice price)

Indenture

14-3

Different Issuers of Bonds

U.S. Treasury
Notes and Bonds
Corporations:
Straight bonds
Bonds with embedded options
Callable bonds
Convertible bonds
Puttable bonds (extendable bonds)
Cap on a floater
Floor on a floater

Municipalities
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14-5

Vietnamese bonds market

Primary market:
Automated bond system (ABS on HNX)
HNX organizes bond biddings via bidding member
system, where non-member individual and
institutions can buy bonds through bidding members.

Secondary market:
Electronic bond trading system (eBTS - HNX)
Only HNX members are allowed to trade directly
on EBT; individuals, non member institutions will
trade through a HNX member which provides GB
brokerage services.

14-6

Vietnamese bonds market

Bonds traded on HNX
Government Bond
Government-Underwritten Bond
Municipal Bond
T Bills

Types of transactions
Outright trading:
bond trading without a repurchase agreement

Repos trading
the seller or transferor commits to repurchase the
bond after a certain time at a pre-determined price.
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Vietnamese bonds market

Source: HNX, as at 14/9/2015

14-8

Treasury bills - HNX

14-9

Bond trading Primary market - HNX

14-10

Vietnamese bonds market

Who are bond investors?

Bond market is affected seriously by

monetary policies.
Strong demand for short term bonds.
Vietnam Bond Market Association
(VBMA)
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14-12

Bond Pricing

PB =
Ct =
T =
y =

Price of the bond

interest or coupon payments
number of periods to maturity
semi-annual discount rate or the semi-annual
yield to maturity

14-13

Pricing a coupon-paying bond

Given a yield of 3.6% p.a. on a 2-year 4.5% p.a.
bond with principal of $100 000, price can be
calculated as:

14

14-14

Pricing a coupon-paying bond

The price of a coupon paying bond can be
greater than or less than the face value of the
bond.
Example:
Consider a bond with a coupon rate of 4.5% p.a.,
term of 2yrs and a face value of $100.

15

14-15

Pricing a coupon-paying bond

Where the coupon rate is less than the yield,
the bond price is less than the principal, and
vice versa.
To summarise:

16

14-16

Bond Prices and Yields

Prices and Yields (required rates of
return) have an inverse relationship
When yields get very high the value of
the bond will be very low.
When yields approach zero, the value of
the bond approaches the sum of the
cash flows.

14-17

Prices and Coupon Rates

Price

Yield
14-18

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14-20

Why did the bond price

change that way?

14-21

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Bond: Secondary market (14/9/2015 HNX)

14-23

SBV interest rates (Sep 2015)

14-24

Yield to Maturity
Interest rate that makes the present
value of the bonds payments equal to
its price.
Solve the bond formula for r

14-25

Yield to Maturity Example

10 yr Maturity

Coupon Rate = 7%

Price = $950
Solve for r = semiannual rate

14-26

Yield Measures

14-27

Other yields
Yield to call
Realised compound yield
Holding period return

14-28

Estimating the yield curve

Yield curve is the relationship between yield and
time to maturity.
It is assumed that securities differ only in terms
of their time to maturity.
If the yield curve and the time to maturity is
known for a money market security, the security
yield can be read from an appropriate yield
curve.
The yield curve is used for pricing bonds not
currently traded.

14-29

Yield Curve
Yield
6.25%

US Treasury yield curve: June, 1999

6.00%
5.75%

Expectations
Liquidity Preference
Inflation-premium

5.50%
5.25%

10

15

20

25

30

Years to Maturity
Source: Financial Times - Mastering Finance

30

14-30

Yield Curve: Inverse

Yield
6.25%

Expectations
Government policy
Market segmentation

6.00%
5.75%
5.50%
5.25%
0

10

15

Source: Financial Times - Mastering Finance

20

25

30

Years to Maturity
31

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14-32

Vietnams Yield Curve (Sep 2015)

14-33

Vietnams Yield Curve (Sep 2015)

14-34

Vietnams Yield Curve (Sep 2015)

14-35

Case: Vietnamese Government Bond

14-36

14-37

ISSUE RESULTS

14-38

Default Risk and Ratings

Rating companies
Moodys Investor Service
Standard & Poors
Duff and Phelps
Fitch

Rating Categories
Investment grade
Speculative grade

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40

14-40

Factors Used by Rating Companies

Coverage ratios
Earnings/fixed costs

Leverage ratios (D/E ratios)

Liquidity ratios(current ratio, quick ratio)
Profitability ratios
rate of return on assets or equity

Cash flow to debt

total CF to outstanding debt

14-41

Ratios

14-42

43

14-43

44

14-44

Australian Governments Bonds

14-45

Historical net debt to GDP ratio

14-46

Vietnam 2009 2010 rating

14-47

Vietnamese Banks Rating - 2009

14-48

Government bonds rating

14-49

14-50

Protection Against Default

Bond indenture provides
Sinking funds
funds saved for payments of face value at maturity

Subordination of future debt

Restrict additional borrowing
Additional borrowings subordinated debt and junior
bondholders

Dividend restrictions
Limit dividend payouts reinvestment of cash

Collateral
Assets received by bondholders in case of default
14-51

Other risks
Interest rate risk
Yield curve risk
Call and prepayment risk
Reinvestment risk
Credit risk
Liquidity risk
Exchange rate risks
Inflation risk
Volatility risk
Event risk
Sovereign Risk
14-52

Special bonds development

TIPS
STRIPS
Mortgage pass through securities
Collateralised Mortgage Obligations
(CMO)
Tax backed debts
Revenue bonds
Credit enhanced debts

14-53