CFA I Equity/Debt

• Leverage factor - 1/margin%
• Levered return - HPR x Leverage factor

difference between k and g widens, value of stock falls

P/E = Payout ratio/(k-g)

• Leading P/E = price/forecast EPS next 12 months
• Trailing P/E = price/EPS for past 12 months

• Bullet bonds - lump sum at maturity pays entire principal
• Serial bonds - pay off principal through series of payments over time
• Sinking fund provision - provide for bond retirement through predefined principal payments over life of the issue
• Call provision - issuer has right to retire all or part of an issuance at a set schedule and price
• Refunding provision - nonrefundable bonds prohibit premature retirement of an issue from proceeds of a lower coupon bond. Freely callable, but nonrefundable

Average % movement (up or down)/value change in yield

takes embedded options into account, unlike modified duration

• Ex: P = 50
• if yield goes down .5%, P = 54
• if yield goes up .5%, P = 48
• Average movement = (54-50 + 50-48)/2 = 3
• Average % movement = 3/50 = 6%
• Duration = 6%/.5% = 12

%change in price = -Duration*(change in yield in decimal form) + convexity*(change in yield in decimal form)^2

duration of a floater is the time to the next reset date

DURATION IS APPROXIMATE

• Expectations hypothesis: yield curve shape reflects investor expectations about future behavior of short-term rates
• Liquidity preference theory: investors prefer greater liquidity, so longer term bonds will include a liquidity risk premium
• Market segmentation: Market for debt securities is segmented on basis of investor maturity preferences. Each segment's interest rate is determined by supply and demand.

full valuation > duration/convexity > duration

full valuation: start with market yield and price, estimate hypothetical changes in yields, recompute bond price using new yields, compare resulting price changes

duration/convexity and duration are summary measures that sacrifice accuracy for simplicity

unsecured, backed by the

current yield will always be between coupon rate and ytm

if selling at a premium, coupon rate > current yield > ytm

if selling at a discount, ytm > current yield > coupon rate

interest rate that is added to each zero-coupon bond spot rate that will cause the present value of the risky bond's cash flows to equal its market value

not used for bonds with options

z-spread = option adjusted spread + cost of the call option in percent

Dollar price change = yield change in decimal form*duration*(price+accrued interest)

Price Value of a Basis Point: how much the price will change given a 1 bp change in yield

PVBP = .0001*duration*(price+accrued interest)

total amount paid by issuer - amount received by issuer

• Ex. 10% coupon, 8% ytm, semiannual, 5 years, 1000, pv 923
• Interest expense = 10*40 + 1000 - 923

not all are tax exempt

investors may be taxed on capital gains

moral obligation bong = no legal obligation to pay

issuer breaks bond covenants, like maintaining a certain debt-to-equity ratio

time on x, yield on y

cum coupon - buyer has the right to the next coupon, and pays the seller accrued interest. This is the way bonds are traded in the U.S. and many other countries

ex coupon - buyer forfeits the right to the next coupon, which should be taken into account when calculating price

issuer is in default and the bond is trading without accrued interest

a fixed component will increase volatility

a cap will increase volatility

reset dates that are farther apart will increase volatility

a third party guarantees bond performance

government, another firm, or insurance

rating can only be as high as the guarantor

• regular redemption price: bonds are redeemed based on call provisions in the indenture
• special redemption price: bonds are redeemed to comply with sinking fund provisions

a prepayment for a portion of the principal

the result of a call option on a bond, it hurts price appreciation

accrue interest over the life of the bond, then pay it out with the final principal or according to some schedule of future principal/interest payments

Bank Discount-Basis Yield:

Money Market Yield:

Bond Equivalent Yield: