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TRADING STRATEGIESFOR DEBT MARKET
T Ramji [email protected]
Coverage of the Presentation
Fixed Income Market
Concept of Yield
Yield Curve Analysis
FIXED INCOME MARKET
FINANCIAL MARKETFINANCIAL MARKET
MONEY MARKETMONEY MARKET
FOREX MARKETFOREX MARKET
CAPITAL MARKETCAPITAL MARKET
CALLCALL REPOREPO TERMTERM CPs,CDs,BillsCPs,CDs,Bills
DEBT MARKETDEBT MARKET
G-SECSG-SECS BONDSBONDS
Trading in Fixed Income Market
Telephone Based MarketTypes of Deals
Direct DealsBrokered Deals
Asking for a quoteShowing the sideAsking for two way
Quote ConventionsGeneration of a quote depends upon
buying/selling pressureSettlement standardized on T + 1 basisChecking of QuotesClosing the Deal
Calculation of Settlement Amount
Principal Amount is calculated as follows:
Face Value x Price
100
e.g. Rs 1 crore face value is purchased at Rs 100.50. The principal amount will be
Rs 1,00,00,000 x 100.50 = Rs 1,00,50,000
100Accrued Interest: The interest accrued since
last interest payment date has to be paid by buyer to seller
Calculation of Settlement Amount No of days for accrued interest: 30/360 day
count convention is used :• Every month is assumed to have 30 days and the year
is assumed to have 360 daysE.g 7.40% GOI 2012
• Interest payment dates 03/05 and 03/11
• Settlement date is 1st July • No of days will be calculated as:
May : ( 30 – 2) = 28 days * May is assumed to have 30 daysJune : 30 days
Calculation of Settlement Amount
No of days for accrued interest : 58 daysAccrued interest = 58 x 7.40 x 1,00,00,000 = 1,19,222.22
360 x 100 Total consideration amount = Principal
amount + Accrued Interest= 1,00,50,000 +
1,19,222.22= 1,01,69,222.22
Concept of Yield
Current YieldCurrent Yield is the annual return on the bond
based on the purchase price. = Coupon Rate x 100
Purchase PriceE.g. 11.50% GOI 2011 at a price of Rs 128
11.50 = 8.98%
128Discount Bonds - Current Yield > CouponPremium Bonds - Current Yield < Coupon.Par Bonds – Current Yield = Coupon
Yield To MaturityA Bond is seen as a series of Cash flowsAll the Cash flows on a bond are discounted to
the present value using Present Value Discount Factors
The rate at which the Present Value of the Future Cash Flows are equated to the Market Price of the Bond is the called as the Yield to Maturity (YTM).
YTM is nothing but the IRR on the bond
Sources of Cash FlowsThe return from a bond consists of 3 components:The regular interest receipts in the form of couponsThe interest from the reinvestment of such receipts The capital gain / loss upon maturity or upon selling
the bond
Yield To Maturity
The return that is earned if held till maturity The YTM on an instrument is dependent upon
a number of factors like:* Coupon Rate;* Premium/Discount on the bond;* Frequency of the compounding;* Balance maturity of the bond;* Redemption Value of the Instrument;
There is an inverse relationship between price
of the security and its Yield to Maturity.
E.g. 10.20% GOI 2007 with a face value of Rs 100 is issued at Rs 110 On 1st Jan 2005, the YTM is calculated as:
62 )1(
10.105............
)1(
10.5
)1(
10.5110
ytmytmytm
Yield To Maturity
Calculation of YTMTrial Value of YTM = 6.45
Time period
IP Date
Coupon
Discount factor
Discounted cash flow
1 12 Jan 05
5.10 0.9688 4.9407
2 12 Jul 05
5.10 0.9385 4.7863
3 12 Jan 06
5.10 0.9092 4.6368
4 12 Jul 06
5.10 0.8808 4.4919
5 12 Jan 07
5.10 0.8532 4.3516
6 12 Jul 07
105.10 0.8266 86.8747
110.0819
Calculation of YTM
Time period
IP Date
Coupon
Discount factor
Discounted cash flow
1 12 Jan 05
5.10 0.9685 4.9395
2 12 Jul 05
5.10 0.9380 4.7840
3 12 Jan 06
5.10 0.9085 4.6334
4 12 Jul 06
5.10 0.8799 4.4876
5 12 Jan 07
5.10 0.8522 4.3463
6 12 Jul 07
105.10 0.8254 86.7486
109.9393
Trial Value of YTM = 6.50
Calculation of YTM
Time period
IP Date
Coupon
Discount factor
Discounted cash flow
1 12 Jan 05
5.10 0.9686 4.9400
2 12 Jul 05
5.10 0.9382 4.7850
3 12 Jan 06
5.10 0.9088 4.6348
4 12 Jul 06
5.10 0.8803 4.4894
5 12 Jan 07
5.10 0.8527 4.3485
6 12 Jul 07
105.10 0.8259 86.8023
110.00
Trial Value of YTM = 6.48
Bonds & YieldsBond & Yields have inverse relationshipBond Prices fall on rise in yieldsBond Prices rise on fall in yieldsYou should have a long position in a
falling yield scenario and short position in a rising yield scenario
In India, shorting in the cash market is prohibited by RBI
Yield Curve Analysis
Yield CurveYield Curve is plot of YTM versus the no of years to
maturity
5.00
5.50
6.00
6.50
7.00
7.50
8.00
1 3 5 7 9 10 13 15 20 25 30Years to Maturity
YT
M
Yield CurveSteepness of the Curve
Steep CurveFlat CurveInverted Curve
Slope of the CurveShifts in the Yield Curve
Parallel ShiftNon-Parallel Shift
Trading StrategiesStrategy 1: Kinks in
yield curve Buy 10.47% 2015 Buy 10.47% 2015 and
sell 10.71% 2016
7.17.27.37.47.57.67.77.87.9
88.1
Maturity & Rate SensitivityLonger Maturity Bonds are more sensitive to
interest rate changes than shorter maturity bondsA 1% Decline in yield results in
Price Rise of Rs 0.95 in a 1 year bond (2006 maturity)
Price Rise of Rs 15 in a 30 year bond (2034 maturity)
You should have a longer maturity bonds in your books in a falling yield scenario and shift to short maturity bonds in a rising yield scenario
Coupon & Rate SensitivityLow Coupon Bonds are more
sensitive to interest rate changes than high coupon bonds
Zero Coupon Bonds have the highest price sensitivity
You should run a portfolio of low coupon stocks in a falling yield scenario and high coupon stocks in a rising yield scenario
Embedded OptionsEmbedded options affect the pricingBonds with Put Option command a
premium to other bondsBonds with Call Option trade at a discount
to other bondsBonds with both Call & Put Option are
priced as shorter term instrumentsIf a 10 Year Bond has a Call & Put Option at
the end of 5 Years, the bond is traded at prevailing 5 Year Yields
Debt ResearchTracking of Liquidity Parameters
Daily Call & Repo RatesCall VolumesLAF VolumesCBLO VolumesRefinance AvailmentInflows from Coupon Payments & RedemptionsOutflows from Auctions, OMOs etcFII investmentsRBI intervention in FX market
Debt ResearchTracking Macro-Economic Parameters
Deposit Growth & Credit OfftakeInterest Rate StanceInflationGovernment Fiscal Conditions
Tax Collection Expenditure Levels WMA levels
Money SupplyBalance of PaymentsCondition of Equity Market
Political Situation