Fixed income market

By: Kendrick Chua

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

What are fixed income?

An investment that provides fixed periodic payments and the eventual return of principal

Components of a fixed income Components of a fixed income

Advantages of investing in fixed income

Disadvantages of investing in fixed income

How do you earn from a fixed income?

Interest income from periodic payments Capital appreciation

How do you earn from fixed income?

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

Preferred shares

Company shares that have higher claim than common stocks and typically pay a fixed dividend.

2011 8%

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

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”.

Bonds according to issuer:

Foreign currency-denominated bonds

What are government securities?Evidence of indebtedness issued by the National Government and are free from default

What are corporate bonds?

Bond yieldYield is a figure that shows the return you get on a bond.

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

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

Bond prices move inversely to interest rates

Bond valuation

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)

Yield to maturityAn attempt to measure the compounded rate of return on a bond investment if it were held to maturity.

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

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

Yields rise as the maturity lengthens

Normal yield curve

Long term yields fall below short term yields

Inverted yield curve

Short and long term yields are equal

Flat yield

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

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%

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%

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%