Bonds_Pricing

PRICE GIVEN YTM

COUPON BOND ZERO COUPON BOND
FACE VALUE 100 100
REDEMTION VALUE 100 100
YEARS TO MATURITY 7 7
SETTLEMENT 1-Jan-96 1-Jan-96
MATURITY 31-Dec-02 31-Dec-02
COUPON RATE 8.00% 0
MARKET YIELD (YTM) 12.00% 12.00%
FREQUENCY 2 2

CURRENT PRICE 81.41 44.24

YTM GIVEN PRICE

COUPON BOND ZERO COUPON BOND
FACE VALUE 100 100
REDEMTION VALUE 100 100
YEARS TO MATURITY 7 7
SETTLEMENT 1-Jan-96 1-Jan-96
MATURITY 31-Dec-02 31-Dec-02
COUPON RATE 8.00% 0
CURRENT PRICE 81.41 44.24
FREQUENCY 2 2

YTM 12.00% 12.00%

CURRENT YIELD 9.83% 0

Page 1
 Bond_Principles

1.THE LEVEL OF YTM

LOWER HIGHER
FACE VALUE 100 100 100 100
REDEMTION VALUE 100 100 100 100
YEARS TO MATURITY 7 7 7 7
SETTLEMENT 1-Jan-96 1-Jan-96 1-Jan-96 1-Jan-96 Market Yield (YTM) cell
MATURITY 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02 value has been changed
COUPON RATE 8.00% 8.00% 8.00% 8.00%
MARKET YIELD (YTM) 8.25% 8.00% 11.00% 10.75%
FREQUENCY 2 2 2 2

CURRENT PRICE 98.69 100.00 85.62 86.71

% CHANGE IN PRICE 1.33% 1.28%

LOWER THE INITIAL YTM, HIGHER THE PRICE CHANGE FOR A CHANGE IN YTM

2. THE DIRECTION OF CHANGE IN YTM

INCREASE IN YTM DECREASE IN YTM

FACE VALUE 100 100 100 100
REDEMTION VALUE 100 100 100 100
YEARS TO MATURITY 7 7 7 7
SETTLEMENT 1-Jan-96 1-Jan-96 1-Jan-96 1-Jan-96 Market Yield (YTM) cell
value has been changed
MATURITY 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02
COUPON RATE 8.00% 8.00% 8.00% 8.00%
MARKET YIELD (YTM) 8.25% 8.50% 8.25% 8.00%
FREQUENCY 2 2 2 2

CURRENT PRICE 98.69 97.40 98.69 100.00

% CHANGE IN PRICE -1.30% 1.33%

PRICE MOVEMENTS RESULTING FROM EQUAL ABSOLUTE INCREASES AND

DECREASES IN YIELDS ARE ASYMMETRIC. A DECREASE IN YIELD RAISES
BOND PRICES MORE THAN INCREASES IN BOND YIELD DECREASES PRICES

3. THE COUPON RATE

SMALLER LARGER
FACE VALUE 100 100 100 100
REDEMTION VALUE 100 100 100 100
Market Yield (YTM) cell
YEARS TO MATURITY 7 7 7 7 value has been changed
SETTLEMENT 1-Jan-96 1-Jan-96 1-Jan-96 1-Jan-96
MATURITY 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02
COUPON RATE 8.00% 8.00% 9.00% 9.00%
MARKET YIELD (YTM) 8.25% 8.00% 8.25% 8.00%
FREQUENCY 2 2 2 2

CURRENT PRICE 98.69 100.00 103.93 105.28

% CHANGE IN PRICE 1.33% 1.30%

PERCENTAGE CHANGE IN PRICE IS LARGER FOR BONDS WITH SMALLER

COUPON RATE FOR ANY GIVEN CHANGE IN YTM

4. THE DISCOUNT OR PREMIUM FROM FACE VALUE

PREMIUM DISCOUNT
FACE VALUE 100 100 100 100
REDEMTION VALUE 100 100 100 100
YEARS TO MATURITY 7 7 7 7 Market Yield (YTM) cell
value has been changed
SETTLEMENT 1-Jan-96 1-Jan-96 1-Jan-96 1-Jan-96
MATURITY 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02
COUPON RATE 8.00% 8.00% 7.00% 7.00%
MARKET YIELD (YTM) 7.75% 8.00% 7.75% 8.00%
FREQUENCY 2 2 2 2

CURRENT PRICE 101.33 100.00 96.01 94.72

% CHANGE IN PRICE -1.31% -1.34%

BONDS SELLING AT A DISCOUNT ARE MORE SENSITIVE TO CHANGES

IN MARKET YIELDS, ALL OTHER FACTORS REMAINING EQUAL, COMPARED
TO BONDS SELLING AT OR ABOVE PAR. DEEPER THE DISCOUNT,
GREATER THE SENSITIVITY OF A BOND'S PRICE TO A CHANGE IN YIELDS

5. THE MATURITY OF THE BOND

LONGER SHORTER
FACE VALUE 100 100 100 100
REDEMTION VALUE 100 100 100 100
Market Yield (YTM) cell
YEARS TO MATURITY 7 7 5 5
value has been changed
SETTLEMENT 1-Jan-96 1-Jan-96 1-Jan-96 1-Jan-96

Page 2
 Bond_Principles
Market Yield (YTM) cell
value has been changed
MATURITY 31-Dec-02 31-Dec-02 31-Dec-00 31-Dec-00
COUPON RATE 8.00% 8.00% 8.00% 8.00%
MARKET YIELD (YTM) 7.75% 8.00% 7.75% 8.00%
FREQUENCY 2 2 2 2

CURRENT PRICE 101.33 100.00 101.02 100.00

% CHANGE IN PRICE -1.31% -1.01%

LONGER THE REMAINING PERIOD TO MATURITY, HIGHER WILL BE THE

VOLATILITY IN PRICE FOR A GIVEN CHANGE IN YIELDS

Page 3
Duration
Duration measure of the waiting period (average) for the holder to receive cash payment
The duration of a zero maturing in n years = n
The duration of a couppn bond maturing in n years < n

Bond price (P) calculation

P = Sum (C*E -yt)
- where cash flows C are discounted at their resp. interest (y) and year fractions (t)
- and E = euler constant
The Duration (D) is defined
D = [Sum (T*C*E -yt)]/P
- where t = year fractions, P = bond price
- the present values of cash flows divided by bond price gives the prorportional flows
- duration is therefore the weighted time average of all cash flows (proportional)
- the weighting of timing of flows is done by the cash flows
- the sum of wieghts is 1.0
Relationship between bond price and duration
dP/dy = -PD
for small shifts in interest rates
delta P = -P*D* deltay
or in % terms
deltaP/P =D* deltay
Duration (D) assumes that y is expressed with continous compounding
if y is expressed in a frequency of m times a year
Modified Duration = D/(1+y/m)
Convexity
For small changes in interest rates change in value est by duration
For larger changes the linear relation between % change and yield changes breaks down
The risk is substantial over or underestimates of value changes
The convexity is the 2nd difference which changes specific to a bond/portfolio
The convexity is the non-linear move in change in value
More than one estimation is available for convexity

(delta P)/P

porfolio 1 portfolio 2
deltay

One of them based on Taylor series expansion of portfolio value changes is

C = [Sum (T2*C*E -yt)]/P
- where t = year fractions, P = bond price
- the present values of cash flows divided by bond price gives the prorportional flows
- duration is therefore the weighted time average of all cash flows (proportional)
- the weighting of timing of flows is done by the cash flows
- the sum of wieghts is 1.0
- the convexity C has to be adjusted for the frequency of cash flows
- deltaP/P =D* deltay + 0.5 C* deltay^2
- the second part of the equation is the convexity adjustment factor
Non parallel shifts / Curve rotation
- calculate the bond duration
- based on bond duration map into different duration buckets
- sum all bonds in each duration bucket
- use above formula to estimate the change in the value of the bucket
- each bucket can use a different shift hence curve rotation possible
Problems with Duration and Convexity
the ytm problem
- two bonds with different cash flow pattern have the same ytm
- reinvestment risk not factored in
- cash flow mapping as a way out of ytm problem and curve rotation
 Dur_MDur

DURATION AND MDURATION EXAMPLES

1. YIELD CHANGE BY BASIS POINTS 10

Duration calculation uses proportion I.e., 1% =0.01
COUPON ZERO COUPON ZERO
FACE VALUE 100 100 100 100
COUPON 6% 0% 6% 0%
TERM 5 5 5 5
SETTLMNT 1-Jan-90 1-Jan-90 1-Jan-90 1-Jan-90
MATURITY 31-Dec-94 31-Dec-94 31-Dec-94 31-Dec-94
YIELD 9% 9% 9.10% 9.10%
FREQUENCY 2 2 2 2
BASIS 1 1 1 1
PRICE 88.14 64.41 87.77 64.10
DURATION 4.34 5.00
MDURATION 4.16 4.78
R_PRICE CH (10bp) 0.366 0.308 price*duration*1/1000….for 10 bp
R_PRICE CH -0.366 -0.308 price*duration*bp/10000

SUMMARY & COMPARISON OF DURATION vs. ACTUAL

% CHANGE IN PRICE
ACTUAL -0.41% -0.48% difference in prices (%)
PREDICTED BY MDURATION -0.42% -0.48% -duration*(diff in yields)
RUPEE PRICE CHANGE
ACTUAL -0.37 -0.31 difference in prices (Rs.)
PREDICTED BY R_PRICE CH -0.37 -0.31 price*duration*bp/10000

2. DURATION AS TIME ELAPSES

FACE VALUE 100 100

COUPON 12% 12%
TERM 100 10
SETTLMNT 1/1/1950 1/1/2040
MATURITY 12/31/2049 12/31/2049
YIELD 0.11 0.11
FREQUENCY 1 1
BASIS 1 1
PRICE 109.09 105.89
DURATION 10.09 6.43
MDURATION 9.09 5.79

3. DURATION OF A PORTFOLIO OF BONDS

BOND A BOND B BOND C
FACE VALUE 100 100 100
COUPON 12% 10% 11%
TERM 100 10 10
SETTLMNT 1-Jan-50 1-Jan-40 1-Jan-40
MATURITY 31-Dec-49 31-Dec-49 31-Dec-49
YIELD 11.00% 11.00% 11.00%
FREQUENCY 1 1 1
BASIS 1 1 1
PRICE 109.09 94.11 100.00
DURATION 10.09 6.65 6.53
MDURATION 9.09 5.99 5.88
DUR_PORT 7.85 = (Price of bond1/sum of prices of all bonds)* Duration of bond 1 +… +…
MDUR_PORT 7.07 = (Price of bond1/sum of prices of all bonds)* M_Duration of bond 1 +… +…

Page 5
 Yield_Change

BASE 1% INC 1% DEC 2% INC 2% DEC

FACE VALUE 1000 1000 1000 1000 1000
COUPON 11% 11% 11% 11% 11%
SETTLMNT 1-Jan-90 1-Jan-90 1-Jan-90 1-Jan-90 1-Jan-90
MATURITY 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02 31-Dec-02
REDEMPTION 1000 1000 1000 1000 1000
FREQUENCY 1 1 1 1 1
BASIS 1 1 1 1 1
CUR.YLD 9% 10% 8% 11% 7%
PRICE 1149.71 1071.01 1237.07 1000.00 1334.25
% CHANGE -6.84% 7.60% -13.02% 16.05%

Page 6
 b1

0.07

Page 7
 b2

0.08

Page 8
 b3

0.09

Page 9
 b4

0.1

Page 10
 b5

0.11

Page 11
Scenario Summary
Current Values: b1 b2 b3 b4
Changing Cells:
$B$9 9% 7% 8% 9% 10%
Result Cells:
$B$10 1149.71 1334.25 1237.07 1149.71 1071.01
Notes: Current Values column represents values of changing cells at
time Scenario Summary Report was created. Changing cells for each
scenario are highlighted in gray.
 b5

11%

999.98
 Dur_Convexity

DURATION AND CONVEXITY OF BONDS - EXAMPLE

YIELD CHANGE BY BASIS POINTS 100

COUPON ZERO COUPON ZERO

FACE VALUE 100 100 100 100
COUPON 3.66% 0.00% 3.66% 0.00%
TERM 10 8 10 8
SETTLMNT 1-Jan-90 1-Jan-90 1-Jan-90 1-Jan-90
MATURITY 31-Dec-99 31-Dec-97 31-Dec-99 31-Dec-97
YIELD 9.00% 9.00% 10.00% 10.00%
FREQUENCY 2 2 2 2
BASIS 1 1 1 1
PRICE 65.30 49.46 60.52 45.82
DURATION 8.00 8.00
MDURATION 7.66 7.65
CONVEXITY 71.35 62.26

COUPON ZERO
% CHANGE IN PRICE
ACTUAL -7.31% -7.35%
PREDICTED BY MDURATION -7.66% -7.65%
DIFFERENCE 0.34% 0.30%

Page 14
 Convexity_Calc

COMPUTATION AND ADJUSTMENT FOR CONVEXITY

YIELD CHANGE BY BASIS POINTS -300

COUPON 8% 8% % CHANGE IN PRICE

FACE VALUE 100 100
REMEMPTION 100 100 ACTUAL 12.87%
YIELD 10% 7.00% PREDICTED BY DURATION #ADDIN?
SETTLMNT 1-Jan-90 1-Jan-90 ADJUSTMENT FOR CONVEXITY 0.88%
MATURITY 31-Dec-94 31-Dec-94 CONVEXITY ADJUSTED PRICE CHANGE #ADDIN?
FREQUENCY 2 2 CONVEXITY ADJUSTED PRICE CHANGE IS CLOSER TO
BASIS 1 1 ACTUAL PRICE CHANGE
PRICE 92.28 104.16
DURATION 4.18
MDURATION #ADDIN?

1. ITERATIVE FORMULA
period (t) cashflow pvcf t*(t+1) pvcf*t(t+1)
1 4 3.81 2 7.62
2 4 3.63 6 21.77
3 4 3.46 12 41.46
4 4 3.29 20 65.82
5 4 3.13 30 94.02
6 4 2.98 42 125.36
7 4 2.84 56 159.19
8 4 2.71 72 194.93
9 4 2.58 90 232.06
10 104 63.85 110 7023.17
92.28 7965.4

PREDICTED BY DURATION #ADDIN? =M_Duration * (bp difference)=M_Duration%

CONVEXITY IN HALF YRS 78.29 =pvcf*t*(t+1)/{[(1*ytm/f)^f]*pvcf}
CONVEXITY IN YEARS 19.57 =convHY/(f*f)
ADJUSTMENT FOR CONVEXITY 0.88% =0.5*convY/((bp/10000)*(bp/10000))
CONVEXITY ADJUSTED PRICE CHANGE #ADDIN? =M_Duration% + Convexity adj

2. TALYOR SERIES EXPANSION EXPANSION

period (t) cashflow pvcf t2 pvcf % =t2*pvcf%
1 4 3.81 1 0.04 0.04
2 4 3.63 4 0.04 0.16
3 4 3.46 9 0.04 0.34
4 4 3.29 16 0.04 0.57
5 4 3.13 25 0.03 0.85
6 4 2.98 36 0.03 1.16
7 4 2.84 49 0.03 1.51
8 4 2.71 64 0.03 1.88
9 4 2.58 81 0.03 2.26
10 104 63.85 100 0.69 69.19
92.28 77.96

PREDICTED BY DURATION #ADDIN? =M_Duration * (bp difference)=M_Duration%

CONVEXITY IN HALF YRS 77.96 =sum(pvcf%*t2)
CONVEXITY IN YEARS 19.49 =convHY/(f*f)
ADJUSTMENT FOR CONVEXITY 0.88% =0.5*convY*(delta_Y2)
CONVEXITY ADJUSTED PRICE CHANGE #ADDIN? =M_Duration% + Convexity adj

Page 15
Portfolio Analysis
1. Individual Bond Duration
change in Price = Price of bond * Duration * Interest Rate change(Prop)
change in Price% = Duration * Interest Rate change (Prop)
summary and comparison of actual and predicted price changes
-% change in price
actual -0.41% -0.48% difference in prices (%)
predicted by R_PRICE change -0.42% -0.48% -duration*(diff in yields)
-rupee price change
actual -0.37 -0.31 difference in prices (Rs.)
predicted by R_PRICE change -0.37 -0.31 price*duration*bp/10000

2. Portfolio Sensitivity based on Duration

DURATION TOTAL (I%) D*%
BOND 1 4.23 10% 0.42
BOND 2 7.11 13% 0.92
BOND 3 5.67 12% 0.68
BOND 4 8.22 10% 0.82
BOND 5 7.97 10% 0.8
BOND 6 2.11 8% 0.17
BOND 7 6.47 7% 0.45
BOND 8 8.42 2% 0.17
BOND 9 3.34 12% 0.4
BOND 10 6.37 16% 1.02
Portfolio Duration 5.86

predicted by R_PRICE change

3. Porfolio Sensitivity considereing Convexity and Curve Rotation

- use convexity adjustment for individual bonds
- map the bond value to the duration bucket
- calculate the bucket sensitivity
 FlRate_Bonds

BASIC DATA
TYPE OF BOND FRB
FV/RV 100
MATURITY (YRS) 6
COUPON REF+80BPS
MARGIN 80
RESET EVERY 6 MONTHS
CURRENT REF.RATE 10%
COUPON FREQ. 2
CURRENT COUPON 10.80% PRESENT VALUE OF CASH FLOW
MARKET PRICE 99.3098 ASSUMED ANNUAL YIELD SPREAD
80 84 88 96 100
PERIOD REFERENCE RATE CFLOW 10.80% 10.84% 10.88% 10.96% 11.00%
1 10% 5.4 5.12 5.12 5.12 5.12 5.12
2 10% 5.4 4.86 4.86 4.86 4.85 4.85
3 10% 5.4 4.61 4.61 4.61 4.6 4.6
4 10% 5.4 4.38 4.37 4.37 4.36 4.36
5 10% 5.4 4.15 4.15 4.14 4.14 4.13
6 10% 5.4 3.94 3.93 3.93 3.92 3.92
7 10% 5.4 3.74 3.73 3.73 3.72 3.71
8 10% 5.4 3.55 3.54 3.53 3.52 3.52
9 10% 5.4 3.36 3.36 3.35 3.34 3.34
10 10% 5.4 3.19 3.19 3.18 3.17 3.16
11 10% 5.4 3.03 3.02 3.02 3 3
12 10% 105.4 56.07 55.95 55.82 55.56 55.44
PRESENT VALUE 100 99.83 99.65 99.31 99.14

Page 17
COUPON AT ISSUE 5%
MATURITY 1-Sep-99
COUPON RESET & PAYMENT DATES MAR1, SEP1
RESET SPREAD 100
BASE RATE 6 MONTH USTB
PRICE 99
TODAY'S BASE RATE 5.50%
RESET COUPON 6.50%
TIME REMAINING TO MATURITY 4 YEARS
(ASSUMING TODAY IS 1-SEP-95)

SIMPLE CURRENT YIELD 5.05%

RESET CURRENT YIELD 6.57%
ADJUSTED SPREAD TO BASE 1.07%
ZERO COUPON BASIS SPREAD 1.250%
RESET OR ADJUSTED YTM 6.79% -99
YTM OVER BASE RATE 1.29% 0
0
SETTLMNT 1/1/1997 0
MATURITY 12/31/2000 100
COUPON 6.50% 0.25%
PRICE 99
RV 100
FREQ 2
YTM 6.79%