Download Debt Markets - Financial Markets - Lecture Slides and more Slides Marketing in PDF only on Docsity! Debt Markets and Term Structure docsity.com Discount Bonds • No coupon payments, just principal at maturity date (conventionally, $100). • Initially sold at a discount (less than $100) and price rises through time, creating income. • Term T, Yield to Maturity (YTM) r Tt r P )1( 1 + = Tt r P 2)2/1( 1 + = docsity.com Example Dec 18, 2000 • T-Bill maturing March 15, Asked=5.83%, 87 days to maturity. • Discount = 5.83*87/360=1.40891 • Price=100-1.40891=98.59108 • Yield=(1.40891/98.59108)(365/87)=5.995% docsity.com Conventional Bonds Carry Coupons • Conventional Bond Issued at par (100), coupons every six months. • Term is time to maturity. P c r r r rt T T = − + + + ( ( ) ) ( ) 1 1 1 1 100 1 =tP P c r r r rt T T = − + + +2 1 2 1 1 2 1 2 100 1 22 2 ( / ( / ) / ) ( / ) docsity.com Term Structure of Interest Rates • Yield to maturity plotted against term • Also called “The Yield curve” • Usually upward sloping • Inverted yield curve • Hump shaped yield curve docsity.com Irving Fisher Diary at Yale • July 31, 1885 “it is neither politic nor right to study at the expense of one’s health.” Rowing. • “When I fall in love she must be a girl of pure morality, broad culture and fine tastes.” • “I have an earnest desire to be good and useful” • April 4, 1886, roommate dies of a “cold.” • May 29, 1887, “I take great satisfaction in my election to Bones for I felt it to be my first little conquest among men. As a freshman I was afraid of my own voice.” docsity.com Forward Rates • Forward rates are interest rates that can be taken in advance using term structure • J. R. Hicks Value and Capital 1939 )1)(1()1( 21 2 2 frr ++=+ )1()1()1( 11 k k k k k frr ++=+ − − docsity.com Example of Forward Rates • Suppose I in 1925 expect to have £100 to invest in 1926, but want the money back by 1927. How can I guarantee the interest rate on the £100 investment today (1925)? • Buy in 1925 (1+r2 )2/(1+r1) 2-period discount bonds maturing at £100 in 1927. Cost: £1/(1+r1) • Short in 1925 one 1-period discount bond maturing at £100 in 1926. Receive: £1/(1+r1) • I have now locked in the interest rate 1+f=(1+r2)2/ (1+r1) between 1926 and 1927. docsity.com Inflation and Interest Rates • Nominal rate quoted in dollars, real rate quoted market baskets • Nominal rate usually greater than real rate. )1)(1()1( irr realmoney ++=+ irr realmoney +≅ docsity.com Indexed Bonds • Paul Revere, Massachusetts, 1780 • U. S. Treasury, 1997 • TIPS Treasury Inflation Protection Securities, $115 billion outstanding 2000, 2% of US national debt • UK Index-Linked Gilts 20% of debt • France recently issued Euro Index bonds docsity.com
