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102 Session 10

Calculate par yield

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Faculty & Institute of Actuaries & are used
with their permission
Source: www.actuaries.org.uk
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Jargon: What’s a par yield?

It’s a kind of average yield.

The par yield is p%,


where a bond paying a coupon of p% pa is priced at par
200

What does “priced at par” mean? 100

Priced at par means the price is 1, or 100%. 0


Cost Pay
Or, put another way, -100 100 100
(+p)
the price per £100 nominal is £100.
-200

E.g. suppose the 5 year par-yield is 7%.

Then a 5 year bond paying a 7% annual coupon would be priced at


£100 per £100 nominal.

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Specimen Q3

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Specimen Q3

Rough guess:
par yield ≈
…. year spot yield ≈ average
forward rate =
1/3 * (6% + 6½% + 7%) = ….%
0 1 2 3

Par yield is p: bond paying p is priced at par 1 "grows to"


Ie …….. = pv(1) + pv(2) + (100+p)v(3)
=> 100 – …… v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant:
1.06 * 1.065
v(1) = 1/……. 1 1.06 1.06 * 1.065 * 1.07
v(2) = v(1) / 1.065
v(3) = v(2) / …….
⇒p = ……. per £100 nominal 312
⇒Par yield = ……..% (close to guess?)
Specimen Q3

Rough guess:
par yield ≈
3 year spot yield ≈ average
forward rate =
1/3 * (6% + 6½% + 7%) = 6½%
0 1 2 3

Par yield is p: bond paying p is priced at par 1 "grows to"


Ie 100 = pv(1) + pv(2) + (100+p)v(3)
=> 100 – 100 v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant:
1.06 * 1.065
v(1) = 1/1.06 1 1.06 1.06 * 1.065 * 1.07
V(2) = v(1) / 1.065
V(3) = v(2) / 1.07.
⇒p = 6.478 per £100 nominal 313
⇒Par yield = 6.478% (close to guess)
Specimen Q3

Model answer

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Apr 2001 Q8(ii)(b)

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Apr 2001 Q8(ii)(b)

Close guess:
par yield ≈
….. year spot yield =
0 1 2 0.04 + …/1000 = ……………%

Par yield is p: bond paying p is priced at par 1 "grows to"


Ie …….. = pv(1) + (100+p)v(2)
⇒100 – …… v(2) = p[ v(1) + v(2) ].
Interest rate isn’t constant:
v(1) = 1 / (1 + y….) 1.042^2
1.041
v(2) = 1 / (1+y2)….. 1
⇒…….–100 * 1.042-2 = p [ 1.041-1 + 1.042-2]
⇒p% = Par yield = …….% (close to guess?) 316
Apr 2001 Q8(ii)(b)

Close guess:
par yield ≈
2 year spot yield =
0 1 2 0.04 + 2/1000 = 0.042 = 4.2%

Par yield is p: bond paying p is priced at par 1 "grows to"


Ie 100 = pv(1) + (100+p)v(2)
⇒100 – 100 v(2) = p[ v(1) + v(2) ].
Interest rate isn’t constant:
v(1) = 1 / (1 + y1) 1.042^2
1.041
v(2) = 1 / (1+y2)2 1
⇒100–100 * 1.042-2 = p [ 1.041-1 + 1.042-2]
⇒p% = Par yield = 4.198% (close to guess) 317
Apr 2001 Q8(ii)(b)

Model answer

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Apr 2003 Q6(ii)

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Apr 2003 Q6(ii) growth factors

1 at time 0 "grows to" 1 at time 1 "grows to"

1 1.118 1.14
1

1 at time 1 "grows to" 1 at time 0 "grows to"

1.14 x
1.118 / 1.118 /
1 1.058 1 1.118
1.058 1.058
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Apr 2003 Q6(ii)

Rough guess:
par yield ≈
3 year spot yield
= [………x 1.118 / 1.058 ) ]⅓ - 1
= ……..%
0 1 2 3
Par yield is p: bond paying p is priced at par
Ie …….. = pv(1) + pv(2) + (100+p)v(3) 1 at time 0 "grows to"
=> 100 – 100 v(3) = …..[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant: 1.14 x
v(1) = …….. / (1118 / 1.058) 1.118 / 1.118 /
1 1.118
v(2) = 1000 / …………. 1.058 1.058
v(3) = V(1) * ………. / 1140. 321
⇒Par yield = p% = 6.36% (near guess)
Apr 2003 Q6(ii)

Rough guess:
par yield ≈
3 year spot yield
= [1.14 x (1.118 / 1.058 ) ]⅓ - 1
= 6.4%
0 1 2 3
Par yield is p: bond paying p is priced at par
Ie 100 = pv(1) + pv(2) + (100+p)v(3) 1 at time 0 "grows to"
=> 100 – 100 v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant: 1.14 x
v(1) = 1000 / (1118 / 1.058) 1.118 / 1.118 /
1 1.118
v(2) = 1000 / 1118 1.058 1.058
v(3) = V(1) * 1000 / 1140. 322
⇒Par yield = p% = 6.36% (near guess)
Apr 2003 Q6(ii)

Model answer
(assumes you already have calculated the spot rates i1, i2, i3)

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Key question
Understand April 2003 Q6(ii).

It doesn’t matter how many times you see the


answers.

You understand when you can make it seem


straightforward to someone else.

324
Next session: forward prices

END
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