Chapter 12 Supplement A: Fixed-Income Securities Chapter 12 Supplement A Fixed-Income Securities

Chapter 12 Supplement A: Fixed-Income Securities

Chapter 12 Supplement A

Fixed-Income Securities


2005 Kaplan Financial

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Basic Concepts of Lending Securities

Fixed-income securities are securities with specified payment dates and amounts, primarily bonds

Lending securities are securities where an investor of bonds lends funds to the issuer in exchange for a promise to a stream of periodic interest payments and a repayment of the loaned principal at the maturity of the bond



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Basic Concepts of Lending Securities (cont.)

Coupon payments are interest payments paid to the bondholder on a semiannual basis and based on a percentage of the face value, or par value, of the bond

Maturity is the period of time through which the issuer has control over the bond proceeds and the period of time it must continue to pay coupon payments



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Valuation of Fixed-Income Securities

The value of a bond is equal to the present value of the expected future cash flows Cash flows Discount rate Zero-coupon bonds



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Measures of Return

Current Yield = Annual Coupon Market Price Yield to Maturity = IRR Yield to Call

Maturity Call Price



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Corporate Returns vs. Municipal Returns

Tax-exempt yield 1 – marginal tax rate

Pretax yield =



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Types of Fixed-Income Securities

The Money Market Treasury Bills Commercial Paper Certificates of Deposit Banker’s Acceptances Repurchase Agreements

Treasury Notes and Bonds Inflation indexed STRIPS



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Types of Fixed-Income Securities (cont.)

U.S. Savings Bonds Federal Agency Securities Municipal Bonds Corporate Bonds Convertible Bonds Mortgage-Backed Securities and

Collateralized Mortgage Obligations



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Rating Agencies

Standard & Poor’s Moody’s



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Standard Credit Rating System

Investment Grade:

High Grade AAA - AA Aaa - Aa

Medium Grade A - BBB A - Baa

Non-Investment Grade:

Speculative BB - B Ba - B

Default CCC - D Caa - C

Bonds Standard & Poor’s Moody’s

Overall Range AAA - D Aaa - C



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Risks of Fixed-Income Securities

Systematic Risks Interest Rate Risk Reinvestment Risk Purchasing Power Risk Exchange Rate Risk

Unsystematic Risks Default (Credit) Risk Call Risk Liquidity Risk



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Volatility of Fixed-Income Securities

Two key factors that influence volatility are: Coupon rate – the volatility in price for a

bond is inversely related to the bond’s coupon payment when interest rates change

Maturity – bonds with longer terms are subject to more volatility with changing interest rates than bonds with shorter terms



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Term Structure of Interest Rates

Yield Curves Yield Curve Theories

Pure Expectations Theory Liquidity Preference Theory Preferred Habitat Theory Market Segmentation Theory



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Duration & Immunization

Duration – a concept developed by Fred Macaulay in 1938 that provides a time-weighted measure of a security’s cash flows in terms of payback

Immunization – the concept of minimizing the impact of changes in interest rates on the value of investments



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Uses for Duration

Measuring a bond’s volatility Estimating the change in the price

of a bond based on changes in interest rates

Immunizing a bond or bond portfolio against interest rate risk



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Traditional Methods of Immunizing Bond Portfolios

The Ladder Strategy The Barbell Strategy The Bullet Strategy

Documents

Chapter 12 Supplement A: Fixed-Income Securities Chapter 12 Supplement A Fixed-Income Securities