|BASICS |FIXED INCOME |
|- long position – trader commits to purchase asset on delivery date (profit if Passet↑) |- Fixed Income instruments: treasury bonds, municipal bonds, mortgage backed bonds, corporate bonds. |
|- short position – trader commits to deliver asset on delivery date (profit if Passet↓) |- Types of Bonds |
|- call option – right to purchase for specified price prior to exp date (profit if Passet↑) |- Callable bonds: allow issuing firm to retire bonds before maturity at a specified price |
|- put option – right to sell an asset for specified price prior to exp date (profit if Passet↓) |- Zero coupon (pure discount) bond: no periodic interest and single payment at maturity |
|RETURNS |- Perpetuity Bonds: last forever and pay only interest |
|- Gross Return: |- Annuity Bond: bond that pays a mix of interest and principal for finite amount of time |
|- Define |- Yield to Maturity: internal rate of return on the bond; YTM ↑(P↓ |
|- Rt+1 is gross return from time t to t+1 |- Formulas: |
|- Rt+2 gross return from t+1 to t+2 |- Zero Coupon (YTM): rf = (F/Pj)1/j – 1 (maturity in j periods, current price Pj and face value F) |
|- Rt+2(2) gross return from t to t+2 |- Zero Coupon (Price): Pj = F/(1+rj)j |
|- Formulas: |- Coupon (Price): P = C/(1+y) + C/(1+y)2 +…+ (C+F)/(1+y)j – j periods to maturity |
|- Rt+1 = (dt+1)/Pt + (Pt+1)/Pt |- Bond Equivalent Yield: 2*YTM as approximate annualized version |
|- Rt+2(2) = (Rt+1)(Rt+2) |- At par: Pbond=F and BEY = coupon rate; coupn rate > BEY ( premium; coupn < BEY ( discount |
|- Net Return: = inc. yld + cap. gain/loss |- Interpreting YTM |
|- Define |- YTM is average per period return assuming: 1) you hold bond to maturity, 2) you reinvest coupon . |
|- inc. yield: cash payouts received by investor |payments at YTM and 3) it is the IRR on the bond. |
|- cap. gain: change in security price |- YTM is not valid measure of “yield” or expected return for coupon bonds because it does not take . |
|- Formulas