1. Fall-02 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html EMBAF Zvi Wiener Based on Chapter 3 in Fabozzi Bond Markets, Analysis and Strategies Measuring Yield

2. Zvi WienerFabozzi Ch 3 slide 2 Yield = IRR = Internal Rate of Return Yield

3. Zvi WienerFabozzi Ch 3 slide 3 FRM-98, Question 12 A fixed rate bond, currently priced at 102.9, has one year remaining to maturity and is paying an 8% coupon. Assuming that the coupon is paid semiannually, what is the yield of the bond? A. 8% B. 7% C. 6% D. 5%

4. Zvi WienerFabozzi Ch 3 slide 4 FRM-98, Question 12 y s = 5%

5. Zvi WienerFabozzi Ch 3 slide 5 Annualizing Yield Effective annual yield = (1+periodic rate) m -1 examples Effective annual yield = 1.04 2 -1=8.16% Effective annual yield = 1.02 4 -1=8.24%

6. Zvi WienerFabozzi Ch 3 slide 6 Bond selling atRelationship ParCoupon rate=current yield=YTM DiscountCoupon rate<current yield<YTM PremiumCoupon rate>current yield>YTM Yield to call uses the first call as cashflow. Yield of a portfolio is calculated with the total cashflow.

7. Zvi WienerFabozzi Ch 3 slide 7 YTM and Reinvestment Risk YTM assumes that all coupon (and amortizing) payments will be invested at the same yield.

8. Zvi WienerFabozzi Ch 3 slide 8 YTM and Reinvestment Risk An investor has a 5 years horizon BondCouponMaturityYTM A5%39.0% B6%208.6% C11%159.2% D8%58.0% What is the best choice?

9. Zvi WienerFabozzi Ch 3 slide 9 Yield to Call Yield to Put Yield to Worst Spread for a floater Total return for a bond

10. Zvi WienerFabozzi Ch 3 slide 10 IRR of a portfolio Aggregation of all cashflows and using the same formula.

11. Zvi WienerFabozzi Ch 3 slide 11 Problems with yield Many equivalent ways to measure? Assumes reinvestment. Does not reflect risk. What if investment is very leveraged? Options, Forwards, Swaps

12. Zvi WienerFabozzi Ch 3 slide 12 Example Cost: 101 Promised cashflow: After 1 year6 After 2 years7 After 3 years8 After 4 years9 After 5 years110

13. Zvi WienerFabozzi Ch 3 slide 13 Yield calculation y = 7.6%

14. Zvi WienerFabozzi Ch 3 slide 14 Example 2 Cost: 101 Promised cashflow: After 1 year6 After 2 years7, callable at 100 After 3 years8 After 4 years9 After 5 years110

15. Zvi WienerFabozzi Ch 3 slide 15 Yield to Call calculation y = 5.94%

16. Zvi WienerFabozzi Ch 3 slide 16 How to treat Floaters Floater is similar to a constantly renewed loan with fixed spread (!). Thus the yield of a floater is equal to the yield on the basis plus the spread. Note that some of the Israeli government bonds have funny linkage to other bonds.

17. Zvi WienerFabozzi Ch 3 slide 17 Questions 1, 2, 5, 7, 10 Home Assignment Chapter 3

18. Zvi WienerFabozzi Ch 3 slide 18 Reverse (Inverse) Floater USD 5 year interest rates are 5%, however short term interest rates are Libor =2%. Libor = London Interbank offered rate on Bloomberg see FWCV + currency One can construct so-called reverse floater:

19. Zvi WienerFabozzi Ch 3 slide 19 Reverse Floater Years 0 1 2 3 4 5 bond -100 5 105 loan +100 -L 0 -L 1 -L 2 -L 3 -100- L 4 Reverse Fl. -100 8 10-L 1 10-L 2 10-L 3 110- L 4 bond -100 5 105