Investment and Portfolio Management. Lecture 8 Bond Prices and Yields. Bond Characteristics

Transcription

1 Investment and Portfolio Management Ms. Pham Le Thu Nga Lecture 8 Bond Prices and Yields Chapter 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

2 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 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

3 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 Vietnamese bonds market Source: HNX, as at 14/9/ Treasury bills - HNX 14-9

4 Bond trading Primary market - HNX 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)

5 Bond Pricing P B = Price of the bond C t = interest or coupon payments T = number of periods to maturity y = semi-annual discount rate or the semi-annual yield to maturity 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 $ , price can be calculated as: 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 $

6 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: 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 Prices and Coupon Rates Price Yield 14-18

7 Why did the bond price change that way? 14-21

8 14-22 Bond: Secondary market (14/9/2015 HNX) SBV interest rates (Sep 2015) 14-24

9 Yield to Maturity Interest rate that makes the present value of the bond s payments equal to its price. Solve the bond formula for r Yield to Maturity Example 10 yr Maturity Coupon Rate = 7% Price = $950 Solve for r = semiannual rate Yield Measures 14-27

10 Other yields Yield to call Realised compound yield Holding period return 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 Yield Curve Yield 6.25% 6.00% US Treasury yield curve: June, % 5.50% Expectations Liquidity Preference Inflation-premium 5.25% Years to Maturity Source: Financial Times - Mastering Finance 14-30

11 Yield Curve: Inverse Yield 6.25% 6.00% Expectations Government policy Market segmentation 5.75% 5.50% 5.25% Source: Financial Times - Mastering Finance Years to Maturity Vietnam s Yield Curve (Sep 2015) 14-33

12 Vietnam s Yield Curve (Sep 2015) Vietnam s Yield Curve (Sep 2015) Case: Vietnamese Government Bond 14-36

13 14-37 ISSUE RESULTS Default Risk and Ratings Rating companies Moody s Investor Service Standard & Poor s Duff and Phelps Fitch Rating Categories Investment grade Speculative grade 14-39

14 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 Ratios 14-42

15 Australian Government s Bonds 14-45

16 Historical net debt to GDP ratio Vietnam rating Vietnamese Banks Rating

17 Government bonds rating 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

18 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 Special bonds development TIPS STRIPS Mortgage pass through securities Collateralised Mortgage Obligations (CMO) Tax backed debts Revenue bonds Credit enhanced debts 14-53