3 - Introduction To Fixed Income Valuation - Fipm - v1

Summary
FIXED INCOME PRODUCTS • Introduction

AND MARKETS • Prices and Yields in practice
Quotation details
Terminology
3. Introduction to Fixed T-Bills
T-Notes and T-Bonds
Income Valuation Discounted Cash Flows
Yields of T-Bills and BEY
Prices and Yields to Maturity
Current Yield
Yield to Call
José Azevedo Pereira Price-Yield Relationship
Day Count Conventions
José A. de Azevedo Pereira Fixed Income Products and Markets 2
1. Brief Review of Discounted Cash

Terminology Flow Valuation
• Bid Ask n
CFi
• Coupons Pt = 
•
•
Maturity Date
Quotation Date
t =0 (1 + y ) t
• Settlement Date
• Dated date 2n
CFi
• Previous Coupon Date or Last Coupon Date
Pt = 
• Next Coupon Date y
• Payment Date
t =0
(1 + )t
• Quoted Price, Clean Price or Flat price 2
• Invoice Price or Dirty Price
• Day Count
José A. de Azevedo Pereira Fixed Income Products and Markets 3 José A. de Azevedo Pereira Fixed Income Products and Markets 4
2.2 Yield to Maturity or Internal Rate of 2.2 Yield to Maturity or Internal Rate of
Return Return
• The internal rate of return (IRR) of a bond is normally referred as yield to • Consequently,
maturity in fixed income markets.
• With annual compounding, the price of a bond that pays annual coupons 45 7 " &, ! " 100
of C€ for N years, per 100€ of face value is given by 45 7 9 &, ! 9 100
45 7 : &, ! : 100
# # # # % 100
!" % ' % ( % ⋯%
1%& 1%& 1%& 1%& +
• If the percentage coupon is given by c, such that C = c x 100,
,--. 1+ ,--
!" 10 1%& +
/ ,2/ 3
2.3. Prices in Practice 1/32 = 1 tick
Current Yield
• It corresponds to the relationship between the value of the coupon and • Bond values might be stated in terms of yields and/or prices.
the market price of the bond • US Treasury prices are normally quoted in 32ns and sometimes in units of
32nds, although conversions to decimals are becoming increasingly easy to
access.
C 100c • Example: Treasury Quotes as of February 8, 2022 (for settlement on
February 9)
Ycurrent = =
P P Quoted Price (in Cumputed Price
Maturity in years
units of 32nds) (Decimals)
2 99-05 3/8 99,16796875

3 98-26 3/4 98,83593750
• It can be understood as an approximation of yield to maturity. Naturally, 5 97-15 3/4 97,49218750
10 95-03 95,09375000
only for the case of perpetuities, the current yield will, in effect, coincide 30 91-26+ 91,82812500
with the yield to maturity Source: Bloomberg
1/64 = 1 plus
Where:
91-26+ = 91.828125 = 91 + 26/32 + 1/64
2.3. Prices in Practice (Excel
Functions for Price and Quote 2.4. Prices and Yields of T-Bills
Conversions)
Converting quotes into decimals
• Invoice price (dirty price) of a security: price that the buyer as to pay.
Maturity Quoted Price (in 32nds) Price in decimals • T-bills do not pay any coupons and pay a fixed amount of money at maturity
=> discount instruments => conceptually are zero coupon bonds;
7 98,28 98,875
• T-bills are quoted on a discount yield basis
DOLLARDE(C4;32)
• Example:
Converting a computed price in decimals to a quote in

32nds
Maturity Quoted Price (in 32nds) Price in decimals
98,28
7 98,875
DOLLARFR(D10;32)
• Use the discount yield to calculate the invoice price for both, the 3-month
and the 6-month T-bills mentioned.
2.4. Prices and Yields of T-Bills 2.4. Prices and Yields of T-Bills
• Discount yield:
&'
;<=7>? ! < " =#7?$<!& %$<7# " • BEY for a T-bill with a maturity of fewer than 182/183 days:
360
*&+
P " 100 1 0 '"
100 0 !
&
360 ./0 360 0 ' " 365'
(,-
*&+ 100
P " 100 1 0
(,- 360./0 " 365 % ./0 '
./0
,--1- (,- 2100 0 !3 365
d= ,--
& * "
!
& 360./0
'"
365' ./0 "
365' 2365 % ./0 3
./0 " 360 0 '
Where, 360 0 '
d = discount yield ./0 9 '
n = number
• Discount of days
yield’ two main remaining between settlement date and
shortcomings:
maturity
• Year has 365date;
days, not 360 days;
• Price paid is not 100, but P
*+ 2.4. Prices and Yields of T-Bills
2.4. 2.4.1
Prices and
Yields of a T-
Yields of T-Bills
T-Bill with n < 182 days
P" 100 1 0 (,-
2.4.1 Yield of a T-
T-Bill with n < 182/183 days
360P= 100 360 -100nd
• BEY/Discount Yield:
• n < 182/183 days ,-- (,- 1(,--
d=
• Discount Yield ,--*
• Bond Equivalent Yield (BEY)
,--1- (,-
• Discount yield d=
,-- *
d=
(100 − P ) × 360
100 n
(100 − P ) 365
BEY = ×
P n
365d
BEY =
360 − dn
• BEY is a better measure BEY d

of>the actual return that might be achieved by
investors, if they hold T-bills until its maturity
2.4. Prices and Yields of T-Bills 2.4. Prices and Yields of T-Bills
2.4.2 Yield of a T-
T-Bill with n > 182/183 days 2.4.2 Yield of a T-
T-Bill with n > 182 days
• Industry convention – an interest y (in effect, y/2) is paid after six • Solving the previous equation for y, we will reach the following
months and it is possible to reinvest this interest, expression for the BEY of T-bills with more 182 days to maturity:
& & 365 &

  100 
2
! 1% % 0 1% ! " 100 − 2n  n   2n
+2   − − 1 × 1 − 
2 365 2 2 365  365   365   p 
BEY =
2n
−1
Value of initial 365
investment Interest earned on the BEY > d
reinvested on a previous amount for
semiannual basis the remaining time to • Excel functions TBILLPRICE and TBILLEQ
for one period maturity
• Excel functions
2.4. Prices and Yields of T-Bills
2.4.2 Yield of a T-
T-Bill with n > 182 /183days 2.5. Prices and Yields of T-Notes and T-Bonds
• Quoted price (clean or flat price): normally, not the invoice price;
• Invoice price (dirty price): clean price + accrued interest
• Accrued interest:
LCD SD
NCD
z days
x days
• Interest accrues for the period corresponding to x - z
2.5. Prices and Yields of T-

T-Notes and T-
T-Bonds 2.5. Prices and Yields of T-
T-Notes and T-
T-Bonds
2.5.1 A Special Case: Short Governments 2.5.1 A Special Case: Short Governments
• Short Governments (industry jargon):
• Short Governments (industry jargon): Treasury coupon issues • Rate of return over a period of z days:
that are in their final coupon period; 7
100 %
Accrued interest at settlement date: 2 0 1 & 365
!8 7
607
"<5 " # & • However, in practice, the yield to maturity of short-governments is
26
annualized as:
Invoice price: 7
100 %
!8 " 9!8 % "<5 &" 2 0 1 & 26
!8 7
• Where 9!8 is the flat price • Similarly the invoice price is computed using the yield to maturity as
7
100 %
!8 " 2 01
7
1%&
26
2.5. 2.5.2
Prices andwith
Securities Yields of T-Notes
More than One Coupon and T-Bonds 2.5. 2.5.2
Prices andwith
More than One Coupon and T-Bonds
• Relationship between invoice price, Pt , and y: • The following table reproduces market data related to a US T-Bond for settlement on February 9, 2022:
=>+1, #
100 2
!8 " : % < : Settlement Coupon Bid Price Ask Price Bid Price Ask Maturity
& +1,2 & =2 • Calculate the corresponding (32nds) (32nds) (dec) Price
; =>- ;
1% 1% Date (dec)
2 2 a) Accrued interest; 2022/02/09 1.375% 95-02+ 95-03 95.0625 95.0675 2031/11/15
b) YTM, based on the ask price.
• Possibility of extracting price if we know the yield or the yield if we know

the price
• Functions in Excel: PRICE and YIELD
Calculate:
a) The accrued interest;
b) The YTM of the note.
2.5. 2.5.2
Prices and Yields of T-Notes and T-Bonds
Securities with More than One Coupon
2.5. 2.5.2
Prices andwith
More than One Coupon and T-Bonds
Coupon j (number of
Coupon Power =
Payment
Dates
number
Coupons full coupon
periods)
j + (z/x)
PV Coupons Principal Price Given Yield and Yield Given Price:
Coupon 1,375%
Bid $ 95,078125 15-05-2022 1 $ 0,6875 0 0,525 $ 0,68405
Ask $ 95,093750 15-11-2022 2 $ 0,6875 1 1,525 $ 0,67751
Yield 1,929% 15-05-2023 3 $ 0,6875 2 2,525 $ 0,67104
Settlement date 09-02-2022 15-11-2023 4 $ 0,6875 3 3,525 $ 0,66463
Maturity 15-11-2031 15-05-2024 5 $ 0,6875 4 4,525 $ 0,65828
N 20,000 Coupons to be paid in the
15-11-2024
future 6 $ 0,6875 5 5,525 $ 0,65200
LCD 15-11-2021 15-05-2025 7 $ 0,6875 6 6,525 $ 0,64577
NCD 15-05-2022 15-11-2025 8 $ 0,6875 7 7,525 $ 0,63960
SD 09-02-2022 15-05-2026 9 $ 0,6875 8 8,525 $ 0,63349
z 95,00 15-11-2026 10 $ 0,6875 9 9,525 $ 0,62744
x 181,00 15-05-2027 11 $ 0,6875 10 10,525 $ 0,62145
z/x 0,525 15-11-2027 12 $ 0,6875 11 11,525 $ 0,61551
Accrued interest $ 0,32666 0,32666 15-05-2028 13 $ 0,6875 12 12,525 $ 0,60963
Dirty price (bid) $ 95,40478 15-11-2028 14 $ 0,6875 13 13,525 $ 0,60381
Dirty price (ask) $ 95,42041 15-05-2029 15 $ 0,6875 14 14,525 $ 0,59804
Yield guess (bid) 1,92868% 15-11-2029 16 $ 0,6875 15 15,525 $ 0,59233
PV (Coupons+Principal) guess $ 95,42041 15-05-2030 17 $ 0,6875 16 16,525 $ 0,58667
15-11-2030 18 $ 0,6875 17 17,525 $ 0,58107
15-05-2031 19 $ 0,6875 18 18,525 $ 0,57552
15-11-2031 20 $ 0,6875 19 19,525 $ 0,57002 $ 100,00
PV $ 12,50788 $ 82,913
Calculate de YTM
José A. de Azevedo Pereira Fixed Income Products and Markets 23 Fixed Income Products and Markets 24
José A. de Azevedo Pereira
2.6 Price-Yield Relation
The relationship between isis convex:
prices and yields Convex 2.6 Price-Yield Relation
The relationship between isis convex:
prices and yields Convex
Clean Price (decimals)
180,000
160,000
140,000
120,000
Price (decimals)
100,000
80,000
60,000
40,000
20,000
0,000
0,00% 5,00% 10,00% 15,00% 20,00% 25,00%
YTM
2.7.1 Accrued Interest (1)

• During the period between the (last) coupon date and the (next) ex dividend date each bond is
traded cum dividend => the investor that holds the security at the “dividend” date gets the whole
coupon.
2.7. DAY COUNT CONVENTIONS
• The seller is rewarded by getting the accrued interest inherent to period.
ACCRUED INTEREST CALCULATION • Immediately after the coupon payment the “clean price” equals the “dirty price”.
• Accrued interest “grows” continually until the (next) ex dividend date

2.7.1 Accrued Interest (2) 2.7.1 Accrued Interest (3)
• In the ex-dividend date the price falls (approximately by the present value of the • Immediately after the ex dividend date, the bond starts to be traded ex dividend;
“dividend” (coupon) that is going to be paid;
• In contrast to what happens during the previous phase, it is the seller, not the buyer, that gets the
next coupon;
• At that moment, the “dirty price” falls below the “clean price”, reflecting the • Consequently, it is necessary to compensate the buyer for the fact that he is not going to get the
negative accrued interest that exists during that moment. next coupon, through a reduction in the price paid for the bond.
Slide 31
JAdAP1 JAdAP1 José António de Azevedo Pereira; 28/02/2021
2.7.1 Accrued Interest (4) – an

example UK Gilts
 N − Nxc 
AI = C xt 
 Daybase
Where:
AI: accruedinterest
C: coupon
Nxc : numberof daysbetween th
e ex dividend
dateand the(next)couponpaymentdate(i.e.,7 daysfor UKgilts)
Nxt : numberof daysbetween th
e ex dividenddateand thedate
for thecalculation
DayBase: daycountbase(usually360ou 365)

2.7.1 Accrued Interest (5) 2.7.1 Accrued Interest (6)
• Interest does not accrue on bonds whose issuer has
subsequently gone into default;
For bonds that are trading ex dividend,
• Bonds traded without accrued interest are said to be trading the accrued coupon is negative and would be subtracted from the
flat or clean; clean price
 Days to next coupon 
AI = −C  
• Consequently:  Day Base 
Clean price of a bond = Dirty price - AI
2.7.2 Day Count Conventions(1) 2.7.2 Day Count Conventions(2)

Conventions Accrued Interest
• When determining the number of days between two dates,
Actual/365 Coupon x (days/365) include the first date but not the second;
Actual/360 Coupon x (days/360)
Actual/actual Coupon x (days/ actual

number of days in the
interest period)
30/360 See below
30E/360 See below
2.7.2 Day Count Conventions(3) 2.7.2 Day Count Conventions(4)
• 30/360: • 30E/360:
• If the first date falls on the 31st , it is changed to the 30th, • If the first date falls on the 31st , it is changed to the 30th, of the month;
of the month;
• If the second falls on the 31st it is automatically changed to the 30th.

• If the second falls on the 31st
and the first date is on the
30th or 31st, the second date is changed to the 30th.
2.7.3 Day Count Conventions for Sovereign Debt (2)

Market Coupon Frequency Day count basis Ex-dividend
Period
Germany Annual Actual/actual No
Market Coupon Day count basis Ex-dividend
Frequency Period Ireland Annual Actual/actual No
Australia Semiannual Actual/actual Yes
Italy Annual Actual/actual No
Austria Annual Actual/actual No
Belgium Annual Actual/actual No New Zeland Semiannual Actual/actual Yes
Canada Semiannual Actual/actual No Norway Annual Actual/365 Yes

Denmark Annual 30E/360 Yes
Spain Annual Actual/actual No
Eurobonds Annual 30/360 No
Sweden Annual 30E/360 Yes
France Annual Actual/actual No
Switzerland Annual 30E/360 No
Market Coupon Frequency Day count basis Ex-dividend

Period
UK Semiannual Actual/actual Yes Thank You
US Semiannual Actual/actual No

3 - Introduction To Fixed Income Valuation - Fipm - v1

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

3 - Introduction To Fixed Income Valuation - Fipm - v1

Uploaded by

Copyright:

Available Formats

Summary

FIXED INCOME PRODUCTS • Introduction

José A. de Azevedo Pereira Fixed Income Products and Markets 2

1. Brief Review of Discounted Cash

• If the percentage coupon is given by c, such that C = c x 100,

2.3. Prices in Practice 1/32 = 1 tick

2 99-05 3/8 99,16796875

Converting a computed price in decimals to a quote in

Maturity Quoted Price (in 32nds) Price in decimals

• BEY is a better measure BEY d

& & 365 &

• Interest accrues for the period corresponding to x - z

2.5. Prices and Yields of T-

• Possibility of extracting price if we know the yield or the yield if we know

b) The YTM of the note.

2.7.1 Accrued Interest (1)

• Accrued interest “grows” continually until the (next) ex dividend date

José A. de Azevedo Pereira Fixed Income Products and Markets 28

JAdAP1 JAdAP1 José António de Azevedo Pereira; 28/02/2021

2.7.1 Accrued Interest (4) – an

José A. de Azevedo Pereira Fixed Income Products and Markets 31

2.7.2 Day Count Conventions(1) 2.7.2 Day Count Conventions(2)

Actual/360 Coupon x (days/360)

Actual/actual Coupon x (days/ actual

30E/360 See below

• If the second falls on the 31st it is automatically changed to the 30th.

2.7.3 Day Count Conventions for Sovereign Debt (2)

Canada Semiannual Actual/actual No Norway Annual Actual/365 Yes

Market Coupon Frequency Day count basis Ex-dividend

You might also like