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Study Session 16
Fixed Income: Analysis and Valuation

CFA Level 1 Vol 2 Workbook.indb 337

10/28/2010 8:45:50 AM

338

Study Session 16

Fixed Income: Analysis and Valuation

Study Session 16
Fixed Income: Fi d I Analysis and Valuation
65. Introduction to the Valuation of Debt Securities 66. Yield Measures, Spot Rates, and Forward Rates 67. Introduction to the Measurement ofInterest Rate Risk
Fixed Income Investments

Fixed Income: Analysis and Valuation
• Introduction to the Valuation of Debt Securities
Fixed Income Investments

CFA Level 1 Vol 2 Workbook.indb 338

10/28/2010 8:45:50 AM

Study Session 16

Fixed Income: Analysis and Valuation

339

SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.a, CFAI Vol. 5 p. 4883-Step Bond Valuation Process
Bond value = present value of future cash flows, coupons, coupons and principal repayment 1. Estimate cash flows 2. Determine the appropriate discount rate The risk factors in SS15 all require increases in yield, including liquidity risk, interest rate risk, call/prepayment risk, credit risk/default risk, etc. 3. Calculate present values of promised cash flows

2SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.b, CFAI Vol. 5 p. 488

Difficulties in Estimating the Cash Flow Stream

U Uncertainty about timing of principal cash y g p p flows (e.g., call features, put features, prepayment options, sinking fund provisions) Uncertainty about coupon amounts (e.g., floating-rate coupons) Uncertainty about cash flows due toconversion options or exchange options

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CFA Level 1 Vol 2 Workbook.indb 339

10/28/2010 8:45:51 AM

340

Study Session 16

Fixed Income: Analysis and Valuation

SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.c, CFAI Vol. 5 p. 490

Valuing an Annual-Pay Bond Using a Single Discount Rate
Term to maturity = 3 years y y Par = $1,000 Coupon = 8% annualcoupon Discount rate 12%

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SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.c, CFAI Vol. 5 p. 490

8% Annual-Pay Bond Cash Flows
0 1 2 3

80

80

80 1,000

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CFA Level 1 Vol 2 Workbook.indb 340

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Study Session 16

Fixed Income: Analysis and Valuation

341

SS#16 Fixed Income: Analysis and Valuation Valuation of DebtSecurities LOS 65.c, CFAI Vol. 5 p. 490

Bond Value: 8% Coupon, 12% Yield
80 (1.12)1 80 (1.12)2 80 1,000 (1.12)3 903.933

N = 3; I/Y = 12; PMT = 80; FV = 1,000; CPT PV = $903.93

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SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.c, CFAI Vol. 5 p. 490

Same (8% 3-yr.) Bond With a Semiannual-Pay Coupon

PMT = coupon / 2 = $80 / 2 = $40 N = 2 × # of years tomaturity = 3 × 2 = 6 I/Y = discount rate / 2 = 12 / 2 = 6% FV = par = $1,000 N = 6 I/Y = 6 PMT = 40 FV = 1 000 6; 6; 40; 1,000; CPT PV = –901.65
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CFA Level 1 Vol 2 Workbook.indb 341

10/28/2010 8:45:51 AM

342

Study Session 16

Fixed Income: Analysis and Valuation

SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.c, CFAI Vol. 5 p. 490

8% 3-YearBond With Semiannual Coupon Payments
40 1.061 40 1.062 40 1.063 40 1.06 4 40 1.065 1040 1.066

901.65 901 65

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SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.c, CFAI Vol. 5 p. 490

Price-Yield Relationship Semiannual-Pay 8% 3-yr. Bond

At 4%:

I/Y = 2% N = 6 FV = 1,000 PMT = 40 CPT PV = $1,112.03 I/Y = 4% N = 6 FV = 1,000 PMT = 40 CPT PV = $1,000.00 $1000 00 I/Y = 6% N = 6 FV = 1,000 PMT = 40 CPT PV = $901.65
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At 8%:

At 12%:

CFA Level 1 Vol 2 Workbook.indb 342

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Study Session 16

Fixed Income: Analysis and Valuation

343

SS#16 Fixed Income: Analysis and Valuation Valuation of Debt Securities LOS 65.d, CFAI Vol. 5 p. 492

Price Change as Maturity Approaches
1,142.430 A premium bond (e.g., a 8%...
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