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Fixed Income Notes

by: Austin Siemion

Fixed Income Notes 427

Marketplace > University of Miami > 427 > Fixed Income Notes
Austin Siemion
GPA 3.5
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About this Document

Notes on the last two classes before the final of Fixed Income Markets
Fixed Income Markets
Tie Su
Class Notes




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This 2 page Class Notes was uploaded by Austin Siemion on Wednesday April 27, 2016. The Class Notes belongs to 427 at University of Miami taught by Tie Su in Spring 2016. Since its upload, it has received 7 views.


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Date Created: 04/27/16
 Zero interest rate volatility meaning we know all future forward rates  Positive interest rate volatility means we don’t know the forward rates  With an increase from 10% to 20% interest rate rate volatility, the forward rate will be higher in the upper node and lower in the lower node  If DCF value of bond is 103, but I can call now at 100, then do so because  If DCF bond value is 98 but is putable at 100, then put the bond (cash out) and reinvest o If bond feature has both call and put, figure out when each would be used  Without interest rate volatility, it is easy to make the decision at each node  As interest rate volatility increases, a putable bond value will increase, because putable bond value is straight bond + put  When rates are high and prices are low, you want to put  Ask yield, is the yield based on the ask price  PV- in the effective duration equation is bigger because lower yield implies higher price  You have a callable bond, the yield today is very high, so the callable bond is price very low but so is the straight bond, so you don’t call it o As yields slowly decrease, the value of the callable bond will increase compared to the straight bond that wont change in value  As you decrease yield, duration goes up on a straight bond o For a callable bond, when yields are sufficiently low, the duration of a callable bond is zero  Duration is not “long or short”, duration is a multiplier  Fully understand question 6 on convertibles – stock is 1140 and bond is 1161, the floor or min value is the bigger of the two, so 1161, but the convertible bond price is $1350. The price should never be less than 1161 and it must be higher than 1161. o 1140 could be the winning price if a few years down the road the stock price becomes $70. 70 x 20 = 1400. Bond price = DCF value = $1105 o Convertible bond = MAX(1405,1105) = $1400 (stock component greater than bond component in this case) o The convertible bond can be priced higher than the bigger of the two, because you can collect coupons  Convertible bond could be worth less due to higher chances  Generally, never early exercise o You may consider early exercise, if dividend yield is higher than the current yield, because if you don’t convert, the stock price will drop Interest Rate Options –  Interest rate cap (call) and floor (put)  Underlying asset is an interest rate – 6 month US dollar LIBOR  You can set whatever exercise rates you want for the cap and floor  Cash settlement – semiannually, every 6 months you can exercise (so if option matures two years from now, you can exercise 4 times)  Call is made of 4 caplets o Caplet payoff = MAX(0, spot rate – exercise rate) * duration factor * NP  Floor is made up of 4 floorlets o Floorlet payoff = MAX90, exercise rate – spot rate) * duration factor * NP  All interest rate options are OTC options, they are negotiated  Pricing interest rate options is not on the final  Interest rate options payoff is in the next period, because the interest rate differential is earned over time  Know the payoffs at each exercise date, and be able to tell the size of one caplet cashflow and the time it will be paid (9 months payoff is paid 12 months from today because its interest rate earned)  What is an interest rate collar?????


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