Maturity impact on returns and bond price valuation

[Chintan]

Hi David,

Few doubts on Fixed Income....

1) On Pg. 109 of study notes - For r'ship between maturity and bond rates,
can you pls have an excel file uploaded since it will help understand in a quick way...

2) On Pg. 117, how did we get the value as 111.06.....do we have an excel file for this ?
Can you please help me understand as to how did we arrive at this number....I cud see
the "street method"...but wat is the discount rate tht we've used and the reason behind it...

Is there an alternative to tuckman for fixed income ?...

 

[David Harper CFA FRM]

Hi Chintan,

For both of those spreadsheets are already uploaded.
1) http://www.bionicturtle.com/premium/editgrid/2008_frm_bonds_maturity_versus_price_versus_return/ (see below, starting row 35)
2) http://www.bionicturtle.com/premium/editgrid/frm_2008_bonds_accrued_interest/ (select File > Export As)

On (1), it's a little tricky but keep in mind the idea is that: the forward rate curve is a given. Then, the "long-term" investor buys a 5-year bond which (implictly) locks in the forward rates. Then the short-term investor instead rolls over 1-year bonds; he/she earns the same returns only if the realized rates = forward rate.

On (2) you'll note i got the full price two ways: one way is discounting the cash flow (the larger purple triangle). The shorter way is shown: PV = ($109.43)[(1.02^1-w)]

For the FRM, the fixed income assignment is squarely Tuckman and little else. There is one book I find, your time depending, that could be a helpful supplement: Fabozzi's Fixed Income Analysis, 2nd Edition. But frankly from an exam-taking perspective, I'd spend time in Tuckman as the fixed income basically all Tuckman chapters.

David

 

[Chintan]

Hi David,

Thanks for yr previous reply..

Few more doubts on Fixed Income…

1) DV01 means change in price of Fixed Income security with 1 bps yield “decrease” or yield “change” ?
2) On Pg. 118 for true yield…why did we take the value as 186 where the conventional date was 28-Feb-02 – Thursday and where the conventional date was 28-Feb-03 – Friday….
3) On Pg 127, Point No. 6 – For computing convexity measure, the yield change is taken as 0.01…..and not as 0.005 ? Any specific reason for this……0.005 is taken as yield change for convexity measure….Why cant the same be taken as convexity adjustment…..??

Thanks in advance….
Chintan…

 

[David Harper CFA FRM]

Hi Chintan:

1) Either a decrease or a change (up/down). Price (dollar) change per 1 bps change, so technically due to the convexity, the DV01 is *slightly* different if you shock (change) up 1 bps versus down 1 bps. But as it's a linear approximation in the first place, I don't think we typically fret the difference

2) I don't follow: conventional was 8/31 but true is 9/2. My excel says 9/2 - 2/28 = 186. I'm not sure i get your point.

3) It could be same, no reason. Difference will be very slight

Sure thing...

David

 

[Chintan]

Hi David,

Thanks for yr reply.

Abt the conv date and true date.....its fine.....sorry, i overlooked......its my mistake..

On Pg. No. 105 of yr notes, you mentioned 5.385% as semi-annual compounded rate of return....dont you consider this to be an annual rate which is compunded semi-annualy...?

On Pg. No. 114, you mentioned about re-investment risk as "Risk tht proceeds available for re-investment "MUST" be invested @ lower rates than initial yield..." Should the word "MUST" be replaced by "MAY".......I guess you meant "MAY".......am i right ?

Thanks David for your continued support.....

Regards,
Chintan

 

[David Harper CFA FRM]

Hi Chintan,

On (1), yes i agree that would be better
On (2), yes I agree that is worded incorrectly and should say "may" or "might"

Thanks for your help...

David