FINS2624 – Portfolio Management

Semester 1, 2011

LECTURE 1 – BOND PRICING

WHAT IS A BOND?

A bond is a claim on some fixed future cash flows. A commonwealth government bond (CGB) is a bond which pays semi-annual coupons, in which the maturity date/ coupon payment date is on the 15th of every month. A zero coupon bond is a bond with no coupons. The important information of a bond: 1. 2. 3. 4. 5. 6. • 1. 2. Transaction date: T Settlement date:T+2 Coupon payment dates Maturity date YTM Coupon rate Cum-interest or Ex-interest? If ex-interest If> 7 days to the next coupon payment-----> cum-interest

YIELD TO MATURITY

The Yield to Maturity (YTM) of a bond is: Interest rate that makes the present value of the bond’s

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It is commonly displayed graphically as the yield curve (graph that shows the relationship between yield and maturity). Nb. The shape of the yield curve can change over time as market participants continuously revise their expectations on future inflation, which is one of the key determinants of interest rates.

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Cheryl Mew

FINS2624 – Portfolio Management

Semester 1, 2011

The Term Structure of Interest Rates offers investors an objective way of inferring future interest rates from the yield curve. These future interest rates are called forward rates, denoted f(n,t) – the rate of a “n” year bond in “t” years. For example, f(2,3) is the interest rate of a 2 year bond in 3 years’ time.

YTM, SPOT RATES AND FORWARD RATES

YTM

Yield to maturity of a general coupon bond

Spot Rates (SR) Current Interest Rates “period” annual rate Yield of maturity of zero-coupon rate From time 0 to period t Forward rates (FR) Future interest rates implied by the term structure objective “rollover” rate- “intermediate” In between 2 periods

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