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Chapter 13

Chapter 13. Fixed Income Securities. Basic Concepts of Lending Securities. Fixed income securities are securities with specified payment dates and amounts, primarily bonds

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Chapter 13

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  1. Chapter 13 Fixed Income Securities Chapter 13: Fixed Income Securities

  2. Basic Concepts of Lending Securities • Fixed income securities are securities with specified payment dates and amounts, primarily bonds • Lending securities are securities where an investor of bonds lends funds to the issuer in exchange for a promise to a stream of periodic interest payments and a repayment of the loaned principal at the maturity of the bond Chapter 13: Fixed Income Securities

  3. Basic Concepts of Lending Securities (cont’d) • Coupon payments are interest payments paid to the bondholder on a semiannual basis and based on a percentage of the face value, or par value, of the bond • Maturity is the period of time through which the issuer has control over the bond proceeds and the period of time it must continue to pay coupon payments Chapter 13: Fixed Income Securities

  4. Valuation of Fixed Income Securities • The value of a bond is equal to the present value of the expected future cash flows Chapter 13: Fixed Income Securities

  5. Measures of Return • Current Yield • Yield to Maturity • Yield to Maturity for a Zero-Coupon bond • Yield to Call • Comparing Corporate Returns and Municipals Returns Chapter 13: Fixed Income Securities

  6. Types of Fixed Income Securities • The Money Market • Treasury Bills • Commercial Paper • Certificates of Deposit • Banker’s Acceptances • Repurchase Agreements • Treasury Notes and Bonds • Inflation indexed • STRIPS Chapter 13: Fixed Income Securities

  7. Types of Fixed Income Securities (continued …) • U.S. Savings Bonds • Federal Agency Securities • Municipal Bonds • Corporate Bonds • Convertible Bonds • Mortgage-Backed Securities and Collateralized Mortgage Obligations Chapter 13: Fixed Income Securities

  8. Rating Agencies • Standard & Poor’s • Moody’s Chapter 13: Fixed Income Securities

  9. Bonds Standard & Poor’s Moody’s Investment Grade: qHigh Grade AAA - AA Aaa - Aa qMedium Grade A - BBB A - Baa Non-Investment Grade: qSpeculative BB - B Ba - B qDefault CCC - D Caa - C Overall Range AAA - D Aaa - C Standard Credit Rating System Chapter 13: Fixed Income Securities

  10. Risks of Fixed Income Securities • Systematic Risks • Interest Rate Risk • Reinvestment Risk • Purchasing Power Risk • Exchange Rate Risk • Unsystematic Risks • Default (Credit) Risk • Call Risk • Liquidity Risk Chapter 13: Fixed Income Securities

  11. Volatility of Fixed Income Securities • Two key factors that influence volatility are: • Coupon rate – the volatility in price for a bond is inversely related to the bond’s coupon payment when interest rates change • Maturity – bonds with longer terms are subject to more volatility with changing interest rates than bonds with shorter terms Chapter 13: Fixed Income Securities

  12. Term Structure of Interest Rates • Yield Curves • Yield Curve Theories • Pure Expectations Theory • Liquidity Preference Theory • Preferred Habitat Theory • Market Segmentation Theory Chapter 13: Fixed Income Securities

  13. Duration & Immunization • Duration – a concept developed by Fred Macaulay in 1938 that provides a time-weighted measure of a security’s cash flows in terms of payback • Immunization – the concept of minimizing the impact of changes in interest rates on the value of investments Chapter 13: Fixed Income Securities

  14. Uses for Duration • Providing a measure of a bond’s volatility • Estimating the change in the price of a bond based on changes in interest rates • Immunizing a bond or bond portfolio against interest rate risk Chapter 13: Fixed Income Securities

  15. Traditional Methods of Immunizing Bond Portfolios • The Ladder Strategy • The Barbell Strategy • The Bullet Strategy Chapter 13: Fixed Income Securities

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