Bonds
Mibor
Presented By:
Group4
Aditya Kumar Singh (81124)
Amit Harshvardhan(81126)
Rahul Poswal (81166)
Sumit Garg (81177)
Financial
Market
Money
Market
Capital
Market
Primary
Secondar
y
Primary
Secondar
y
Money Market
Money Market is concerned with the buying &
selling of short term (less than one year original
maturity) government and corporate debt
securities whereas capital market deals with long
term.
Money Market Instrument
Treasury Bills
Certificates of Deposits
Commercial Papers
Intercorporate Deposits
Ready Forwards
Money Market Instrument (cont.)
Bills of Exchange
Bill discounting
Short Term Debentures
Fixed Deposits
Mutual Funds Scheme
Treasury Bills
Issued By RBI.
Maturities of 14, 91, 364 days.
Issued for minimum of Rs 25,000 & its multiples.
Certificates of Deposits
Risk Free Option like TBills.
Issued in denominations of 0.5 mn.
Maturity ranges from 30 days to 3 years.
Commercial Papers
Introduced by RBI.
Issued by Financial companies with credit rating.
Issued in denominations of Rs 5 lakhs or in
multiples.
Duration of 15 days to 1 year.
MIBOR
MIBORMumbai Interbank BidOffer rate.
MIBOR is equivalent to daily call rate.
It is the overnight rate at which funds can be borrowed and
changes everyday
The MIBOR rate is used as a bench mark rate for majority of
deals struck for Interest Rate Swaps, Forward Agreements,
Floating Rate Debentures and Term Deposits.
MIBOR
NSE had developed and launched the NSE Mumbai
Interbank Offer Rate (MIBOR) for the overnight
money market on June 15, 1998
NSE launched the 14day NSE MIBID MIBOR on
November 10, 1998 and the longer term money market
benchmark rates for 1 month and 3 months on December 1,
1998
The exchange introduced a 3 Day FIMMDANSE MIBID
MIBOR on all Fridays with effect from June 6, 2008 in
addition to existing overnight rate.
WHY MIBOR IS USED
Unbiased  The National Stock Exchange of India (NSEIL)
has been trusted by the securities markets for its unbiased
independence and professionalism
Market Representation  based on rates polled by NSE from
a representative panel of 33 banks/ primary dealers.
Transparent  The reference rate is released to all the market
participants simultaneously through various media, making it
transparent
Reliable  The high level of corelation between actual deals
and the reference rate gives an indication of its reliability.
Dissemination of NSE MIBID MIBOR
FIMMDANSE MIBID MIBOR rates are broadcast through
the NEATWDM trading system immediately on release
The NSE website carries the daily rates as well as the
historical data on the FIMMDANSE MIBID MIBOR
FIMMDANSE MIBID MIBOR rates are also carried by all
leading financial dailies including Economic Times, Financial
Express, Business Standard and Business Line.
MIBOR rates are released to contributors and users through E
mail.
MIBOR Methodology
Volume weighted average (VWA) is calculated by averaging
the reported trades after weighting them with their respective
volume.
The VWA needs price volume data of all executed deals and is
a reliable measure of the market
Polling is used for obtaining reference rates by polling a few
market participants and summarizing the prices they report.
The procedure involves querying bid and offer prices from
eight market participants.
MIBOR Methodology
Traded mean: Calculating fixed trimmed mean of the
reported rates have been used by some organizations which
need to use a reference rate.
They collect rates from individual dealers and compute a
reference rate as the trimmed mean is obtained after deleting
"n" highest and lowest observations.
Bootstrapping: The bootstrap technique is a nonparametric
method for computing the test statistics
Computing the reference rate as an average of the polled rates
after an appropriate amount of trimming.
Bonds
Bond is a debt security.
Authorized issuer owes the holders a debt and,
depending on the terms of the bond, is obliged
to pay interest (the coupon) and/or to repay the
principal at a later date, termed maturity.
15
16
Definitions
Par or Face Value 
The amount of money that is paid to the
bondholders at maturity. It generally
represents the amount of money borrowed
by the bond issuer.
Coupon Rate 
The coupon rate, which is generally fixed,
determines the periodic coupon or interest
payments. It is expressed as a percentage
of the bond's face value. It also represents
the interest cost of the bond to the issuer.
17
Definitions
Maturity Date 
The maturity date represents the date
on which the bond matures, i.e., the
date on which the face value is repaid.
The last coupon payment is also paid on
the maturity date.
Yield to Maturity 
The yield to maturity is the interest rate
that brings a bond's original value,
principal payments and interest
payments into equilibrium.
Definitions
Market interest rate The interest rates yielded
by any investment take into account:
The riskfree cost of capital
Inflationary expectations
The level of risk in the investment
The costs of the transaction
18
The basic interest rate pricing model is
I = i
r
+ p
e
+ rp + Ip
Where
i
r
=is the riskfree return to capital
Pe = inflationary expectations
rp = a risk premium reflecting the length of the investment
and the likelihood the borrower will default
lp = liquidity premium
19
Types of Bond
Callable bond
Convertible bond
Perpetual Bond
Bonds with finite Maturity
Non zero coupon Bonds
Zero coupon Bonds
20
21
Bond Valuation
Bonds are valued using time value of money
concepts.
Their coupon, or interest, payments are treated
like an equal cash flow stream (annuity).
22
Example
Assume Ram buys a 10year bond from the KLM
corporation on January 1, 2008. The bond has a face
value of Rs 1000 and pays an annual 10% coupon. The
current market rate of return is 12%. Calculate the price
of this bond today.
1. Draw a timeline
$100 $100
$100
$100
$100
$100
$100
$100
$100 $100
$1000
+
?
?
Perpetual Bond
V = CF/r
= 100/0.12
= 833.33
23
24
Non zero coupon with finite maturity
First, find the value of the coupon stream
PV = 100/(1+.12)
1
+ 100/(1+.12)
2
+
100/(1+.12)
3
+ 100/(1+.12)
4
+
100/(1+.12)
5
+ 100/(1+.12)
6
+
100/(1+.12)
7
+ 100/(1+.12)
8
+
100/(1+.12)
9
+ 100/(1+.12)
10
PV = 565
25
Find the PV of the face value
PV = MV/ (1+r)
t
PV = 1000/ (1+.12)
10
PV = 322
Add the two values together to get the total
PV
V = 565 + $322 = $887
Zero coupon bond with finite Maturity
V = MV/(1+r)
n
= 1000/(1.12)
10
= 322
26
Presented By:
Piyush Mehta (081163)
Sachin Vohra (081173)
Topics To Be Covered
Valuation of Bonds
Yield
Current Yield
Yield to Maturity (YTM)
Yield Curve & Term Structure
Bootstrapping
Nelson Siegel Model (NSE ZCYC)
Current Yield:
Annual Coupon Receipts / Market Price of the
Bond
For example,
if a 12.5% bond sells in the market for Rs.
104.50, current yield will be:
= (12.5/104.50) * 100
= 11.96 %
However current yield does not consider
time value of money, future cash flows,
reinvestment income.
Yield to Maturity (YTM):
Discount rate which equates the price of a bond
with the PV of its expected future cash flows
( ) ( )
n
m
IRR
n
k
k
m
IRR
k C
P
+
+
(
+
=
=
1
100
1
1
Where
n = total no. of periods ( n = mt)
m = no. of coupon payments per year
t = no. of years to maturity
C = periodic coupon rate ( C/m)
P = market price of the bond
Example:
What is the yield to maturity of a 5% coupon 9
year Rs. 1,000 par value bond if the price is Rs.
813 (annual coupons)?
We need to solve the following equation for r :
9
813 = (50/(1+r)^t) + (1000/(1+r)^9)
t=1
Suppose coupons are semiannual:
18
813 = (25/(1+r)^t) + (1000/(1+r)^18)
t=1
What determines interest rates?
investor preferences (e.g. willingness to save
affects the supply of capital)
productive opportunities (e.g. firms desire to
invest affects the demand for capital)
inflation (let i denote the expected rate of
inflation)
inflation erodes the purchasing power of money
) distinguish between nominal and real interest
rates:
1+r nominal = (1+r real)(1+i)
r nominal = r real + i + i * r real
= r real + i
nominal rates will change whenever expected
inflation does
Problems with Yield to Maturity
The same rate is used to discount all payments,
but what if
r1 r2 r3 .. ? For example:
Bond A: 3 years, annual coupon of 5%
Bond B: 3 years, annual coupon of 15%
Spot rates: r1 = :04; r2 = :048; r3 = :054
Calculate the yield to maturity and PV for each
bond:
Yield to maturity can give a misleading
impression of return since it implicitly assumes
that all intermediate payments are reinvested
and earn the same rate of return
Yields to maturity do not add upeven if you
know the yield to maturity for A and the yield to
maturity for B, you do not know the yield to
maturity for A plus B
Until now we have assumed that nominal
interest rates are the same for all future periods;
this allowed us to use
the general PV formula:
T
PV = (Ct /(1+r)^t)
t=1
Using the same YTM rate can lead to erroneous
results because it takes all the coupons have to
be invested for all the time periods at a single
rate
Actually there are different rates in the market
for each of the cash flows
These rates are known as zero coupon rates or
spot rates
Zero Coupon Yield based Valuation
So our new formula becomes:
T
PV = (Ct /(1+rt)^t)
t=1
PV= C/(1 + r1) + C/(1 + r2)^2 +..
. (C+R)/(1 + rm) ^m
Yield Curve
A graph of bond yields to maturity by time to
maturity is called a yield curve.
4.00%
4.50%
5.00%
5.50%
6.00%
6.50%
7.00%
3mo 6mo 1yr 2yr 3yr 5yr 10yr 30yr
Yield Curve Contd
Has different shapes:
Upward Going
Inverted
Flat
NSE estimates the ZCYC from the market prices
and enables the computation of appropriate
discount rates
Zero Coupon Yield based Valuation
Each coupon bond is really a package of
single payment bonds.
For example, a 2year 10% coupon bond is
really a package of five single payment
bonds:
four for the semiannual coupon payments
and
one for the repayment of the principal.
Zeroes
A single payment bond is called a zero.
A coupon bond can be thought of as a
package of zeroes,
one for each of the coupon payments and
one for the principal.
In principle, any coupon bond could be
stripped or unbundled into its constituent
zeroes.
Spot Yields
A spot yield is the current yield to maturity on a
zero.
For example, the 1year spot yield is the yield to maturity
on a 1year zero.
The price (per dollar of corpus) of an nyear zero is
related to the nyear spot rate by the formula:
0
P
n
=
1
1+
i
n
2

\

.
2n
For example, if the 3 1/2 year spot yield is 6.05%,
then the price (per dollar of corpus) of the 3 1/2 year
zero is:
0P3.5 = 1/(1+(.0605/2))^ 7
= 1/(1.03025)^ 7
= 0.811
Alternatively, we can express the nyear spot yield as
a function of the price of an nyear zero:
i
n
= 2
1
0
P
n

\

.

1
2n
1

\

.


Price of a Coupon Bond
n Spot Yield Price of zero Cash flow Value
1/2 5.10% $0.98 $0.0375 $0.0366
1 5.49% $0.95 $0.0375 $0.0355
1 1/2 5.64% $0.92 $0.0375 $0.0345
2 5.82% $0.89 $0.0375 $0.0334
2 1/2 5.88% $0.87 $0.0375 $0.0324
3 5.95% $0.84 $0.0375 $0.0315
3 1/2 6.05% $0.81 $0.0375 $0.0304
4 6.12% $0.79 $0.0375 $0.0295
4 1/2 6.12% $0.76 $0.0375 $0.0286
5 6.19% $0.74 $1.0375 $0.7647
$1.0571
5year 7.5% coupon bond
For Example:
Term Structure
The term structure of interest rates is the
pattern of spot rates over the range of
maturities.
A flat term structure means that spot yields
are equal at all maturities.
A normal term structure slopes upward
An inverted term structure slopes
downward
Bootstrapping
Here we use rates of bonds without intermittent
coupons i.e. Zero Coupon Bonds
However, in most markets zero coupon bonds
across varying tenors dont exist and so we
could bootstrap from the zero coupon treasuries
and derive r1,r2,r3..rn of the coupon paying
bonds
Heres yield curve information
Bootstrapping
Coupon Term (yrs) Yield Price
8.50% 1/2 5.10% $101.66
7.38% 1 5.49% $101.81
9.00% 1 1/2 5.63% $104.78
8.88% 2 5.81% $105.72
6.75% 2 1/2 5.86% $102.03
7.75% 3 5.93% $104.94
6.25% 3 1/2 6.03% $100.69
5.63% 4 6.09% $98.38
6.50% 4 1/2 6.10% $101.56
7.50% 5 6.16% $105.69
The first bond has 1/2 year to run
Its price is $1.0166 per dollar of face value.
Therefore the 1/2 year spot rate is
i1/2 = 2((1.0425/1.0166)^1 1)
= 2(.0255)
= 5.10 %
Bootstrapping
Given the 1/2 year spot rate, we can
determine the price of the 1/2 year zero:
0P1/2 = 1/(1+i1/2/2)^1
= 1/(1+0.0510/2)
= 0.9751
Bootstrapping
For each dollar of face value, the 1year bond
will pay $.03690 in 6 months and $1.03690 in
one year.
Its price should equal:
$ 1.0181 = $ 0.03690/(1+i1/2/2)^1 +
$1.03690/(1+i1/2)^2
Bootstrapping
$ 1.0181 = $ 0.03690/(1+.0510/2)^1 +
$1.03690/(1+i1/2)^2
i1 = 5.49 %
Bootstrapping
Which we can solve for the 1year spot rate as :
Now solving for 0P1
i.e. 0P1 = C1/(1+r0.5)^0.5 + C2/(1+r1)^1
The yield curve is then drawn from these derived zero rates
Bootstrapping
Coupon Maturity Yield Price Zero Price Spot Yield
8.50% 0.5 5.10% $101.66 $97.51 5.10%
7.38% 1 5.49% $101.81 $94.73 5.49%
9.00% 1.5 5.63% $104.78 $92.00 5.64%
8.88% 2 5.81% $105.72 $89.16 5.82%
6.75% 2.5 5.86% $102.03 $86.51 5.88%
7.75% 3 5.93% $104.94 $83.88 5.95%
6.25% 3.5 6.03% $100.69 $81.16 6.05%
5.63% 4 6.09% $98.38 $78.58 6.12%
6.50% 4.5 6.10% $101.56 $76.23 6.12%
7.50% 5 6.16% $105.69 $73.71 6.19%
Spot rate function is given as:
r= 0 + (1+ 2) * [1exp(m/)]/(m/) 2*
exp(m/)
Discount function is given by:
d= exp((r * m)/100)
m= time to maturity
0, 1, 2 = long run ,short run & medium run
components of interest rates
NSE  ZCYC (Nelson Siegel Model)
p_est =PV arrived using discount function
pmkt = actual market prices
Pmkti= p_esti + ei
Minimizing the sum of squared price errors
When m is very large, then value of
r= 0 (non zero constant)
When m tends to zero, then
r= 0
+ 1
NSEZCYC (Nelson Siegel Model)
Steps:
Starting values of parameters (0,1,2,)
Determine the discount function using these
parameters
Determine present values of cash flows thereby
prices of the bonds
Optimize the solution that minimize the sum of
squared price errors
NSEZCYC (Nelson Siegel Model)
Determine the price and also spot rate for each
bond
Plot the spot rates against the maturity values
NSEZCYC (Nelson Siegel Model)
Thank You