fixed income market
DESCRIPTION
Basics of Fixed incomeTRANSCRIPT
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Fixed income market
By: Kendrick Chua
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Outline of discussion
• Definition of fixed income• Pros and cons of investing in fixed income• Different fixed income investments available
in the market• Computing for prices and yield• Exercises
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What are fixed income?
An investment that provides fixed periodic payments and the eventual return of principal
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Components of a fixed income Components of a fixed income
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Advantages of investing in fixed income
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Disadvantages of investing in fixed income
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How do you earn from a fixed income?
Interest income from periodic payments Capital appreciation
How do you earn from fixed income?
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Long term negotiable certificate of deposit
A long term negotiable certificate of time deposit indicating an amount of a bank’s indebtedness with a designated maturity
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Preferred shares
Company shares that have higher claim than common stocks and typically pay a fixed dividend.
2011 8%
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Special deposit accounts
Short-term liability offered by the BSP with tenors ranging from several days to two months
Current interest rate stands at 2.0% as of December 2013
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Bonds
A debt instrument that promises to pay a specified sum of money on a specified date
It’s nothing more than a glorified “utang”.
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Bonds according to issuer:
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Foreign currency-denominated bonds
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What are government securities?Evidence of indebtedness issued by the National Government and are free from default
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What are corporate bonds?
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Bond yieldYield is a figure that shows the return you get on a bond.
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Example 1: How much will a bond with a par value of P1,000 and coupon rate of 8% pay an investor?
P80.00(P1,000 par value x 8%)
P80.00(P1,000 par value x 8%)
Coupon amountPrice
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A debt instrument that does not pay interest but is traded at a discount, with the face value repaid at the time of maturity
Zero coupon bond
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Bond prices move inversely to interest rates
Bond valuation
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Example 2: What is the current yield if the bond price goes down to P980?
8.16%(P80/P980)
8.16%(P80/P980)
Example 3: What is the current yield if the bond price goes up to P1,020?
7.84%(P80/P1,020)
7.84%(P80/P1,020)
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Yield to maturityAn attempt to measure the compounded rate of return on a bond investment if it were held to maturity.
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Example 2: If a P1,000 bond with a 10.0% coupon rate was selling for 92 and matures in 10 years, what is the yield to maturity?
Coupon = P100 (10% X P1,000)Annualized gain = P11.25 ([P1,000 maturity value – P920 current value]/ 10 yearsEstimated average value of investment = P960 ([P1,000+920/2])
P108 = 11.25% P960
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What is a yield curve?
Gives an idea of the future interest rate change and economic activity
Shows the correlation between interest rate and the time of maturity
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Yields rise as the maturity lengthens
Normal yield curve
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Long term yields fall below short term yields
Inverted yield curve
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Short and long term yields are equal
Flat yield
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Exercise 1: How much will a bond holder receive every quarter if he invests P1M in XYZ bond that has a coupon rate of 8%.
P20,000
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Exercise 2: A P1,000 bond that has a coupon rate of 7% sells in the market for P1,100. What is its yield?
6.36%
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Exercise 3: A P1,000 bond that has a coupon rate of 12% sells in the market for P975 What is its yield?
12.31%
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Exercise 4: The bank is offering you two bonds to invest in. One has a maturity of 15 years and a coupon rate of 6.5%. The other matures in 10 years and has a coupon rate of 5.5%. The first bond sells for P1,100 and the second bond sells for P975. Which is the better deal?
Bond B = 5.82%