Assignment on Yield Curves & Hedging

Paper within
Markets and Financial Contracts

Advanced Security

Author:
Aman Chindalia, Varsha Rawat

Abdi Suleiman Kahin,

Tutor:

Agostino Manduchi

Jnkping

December 2015

Table of Contents
1 Pharmaceutical Industry Overview - India....................................
2 Dr Reddys Laboratories Limited..................................................
1

2.1

Introduction

2.2

Companys Financial Information (FY05 FY15)

2.2.1

Revenue

2.2.2

Gross Profit

2.2.3

Profit Before Tax

2.2.4

Profit After Tax

2.2.5

Earnings per Share (in INR) 3

2.2.6

Free Cash Flow to the Firm 3

2.3

Market Capitalisation & Net Worth

3 Key Ratios.....................................................................................
4 Other variables of the stock...........................................................
4.1

PE Ratio5

4.2

Beta Value

4.3

Dividend and Dividend Growth

4.4

Debt to Equity Ratio

4.5

WACC 7

5
6

5 Performance vis-a-vis Competitors and Market.............................

6 Different Valuation Techniques......................................................
7 Future Prospects Growth in Profit and Cash Flow.......................
8 Appendices..................................................................................
12

8.1

Balance Sheet Extract (FY 05 FY15)

8.2

Profit and Loss Account Extract (FY 05 FY 15)

8.3

Abridged Cash Flow (FY 05 FY 15) 14

8.4

Stock Price Movement (FY 05 FY 15)

15

13

Introduction

This assignment is divided into four broad parts. In the first part, we have collected the data
on Swedish Treasury Bonds, distinctive on their maturities as listed on the Nasdaq OMX
Exchange (www.nasdaqomxnordic.com) This data was collected after the closing of
December 8, 2015 and therefore the closing prices and the related calculations are as against
the aforementioned date. We have also appended to the list the features of the bond as
mentione in the Swedish National Debt Office (Riskgalden). In the second part, we have used
the data collected in the first part to build lists representing the bonds given to us in the
wxMaxima file yield_curve as part of the assignment. We used the lists to calculate the yields
to maturity of these bonds one for each bond between 8 th December 2015 and the maturity
of the bond. In the third part, we have calculated the current price of a set of semi-annual
payments of identical amounts (equal to SEK 1 million each) that are due to be received from
January 1, 2015 to July 1, 2025. As mentioned in the assignment, we have assumed the risk
premium for these payments is equal to 1%. In the fourth part, we have used two bonds from
the list to build a hedge for the set of payments in the third part against changes in the yields.

Data Collection

2.1 Swedish Treasury Bonds

The following data has been collected on Swedish Treasury Bonds from the Nasdaq OMX
Exchange as on the closing of December 8, 2015. All prices are in SEK.
Name

ISIN
SE000151769
9

Coupon

RGKB 1051 SE0001811399

3.750%

SE000224108
3

4.250%

RGKB 1047 SE0001149311

RGKB 1050

RGKB 1052

RGKB 1054
RGKB 1057
RGKB 1058
RGKB 1059
RGKB 1056
RGKB 1053

SE000378446
1
SE000486907
1
SE000567660
8
SE000712592
7
SE000451729
0
SE000282919
2

Low

Expiry

102.059

12 July 2016

107.028

12 August 2017

114.47 114.54 114.496

114.46

12 March 2019

5.000%

123.6
8

123.7
4

123.653

1 December
2020

3.500%

119.1

119.21 119.277 119.072

1 June 2022

1.500%

106.2

106.3
1

106.265

13 November
2023

2.500%

114.42 114.54 114.633 114.321

12 May 2025

1.000%

98.47

98.6

108.5
6
127.6
1

109.0
1
128.5
2

3.000%

2.250%
3.500%

Bid
102.0
8
107.0
5

Ask
102.0
8
107.0
7

High
102.07
1
107.05
2
123.78
9
106.27
3

98.671

98.539

12 November
2026

108.89

108.725

1 June 2032

128.73
6

127.718

30 March 2039

2.2 Detailed Features of the Bonds

(RKGB has been replaced
with SGB)

2.2.1

SGB 1050
ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

2.2.2

SE0001517699
3.000%
102.08
102.08
102.071
102.059
12 July 2016
SEK
19 September 2005
12 July 2016
Annual
30E/360
Fixed
12/07/05
0.6
0.59
53,23,89,00,000
54,99,20,56,977

SGB 1051
ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration

SE0001811399
3.750%
107.05
107.07
107.052
107.028
12 August 2017
SEK
15 September 2006
12 August 2017
Annual
30E/360
Fixed
12/08/06
1.7
1.64
2

2.2.3

2.2.4

Nominal Amount
Market Value

65,52,57,75,000
70,93,27,98,139

ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

SE0002241083
4.250%
114.47
114.54
114.496
114.46
12 March 2019
SEK
21 November 2007
12 March 2019
Annual
30E/360
Fixed
12/03/07
3.3
3.04
88,55,01,20,000
1,04,17,30,91,463

ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

SE0001149311
5.000%
123.68
123.74
123.789
123.653
1 December 2020
SEK
28 January 2004
1 December 2020
Annual
30E/360
Fixed
01/12/03
5
4.58
85,55,37,80,000
1,05,96,35,84,817

SGB 1052

SGB 1047

2.2.5

SGB 1054
ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

2.2.6

2.2.7

SE0003784461
3.500%
119.1
119.21
119.277
119.072
1 June 2022
SEK
9 February 2011
1 June 2022
Annual
30E/360
Fixed
01/06/10
6.5
5.88
87,13,05,00,000
1,05,44,60,09,782

SGB 1057
ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

SE0004869071
1.500%
106.2
106.31
106.273
106.265
13 November 2023
SEK
22 October 2012
13 November 2023
Annual
30E/360
Fixed
13/11/11
7.9
7.54
71,97,70,00,000
76,59,45,64,474

ISIN

SE0005676608

SGB 1058

Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

2.2.8

2.2.9

2.500%
114.42
114.54
114.633
114.321
12 May 2025
SEK
3 February 2014
12 May 2025
Annual
30E/360
Fixed
12/05/13
9.4
8.48
53,37,20,00,000
61,88,88,36,900

SGB 1059
ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

SE0007125927
1.000%
98.47
98.6
98.671
98.539
12 November 2026
SEK
22 May 2015
12 November 2026
Annual
30E/360
Fixed
12/11/14
10.9
10.39
38,64,70,00,000
38,12,68,11,380

ISIN
Coupon
Bid
Ask

SE0004517290
2.250%
108.56
109.01

SGB 1056

High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

108.89
108.725
1 June 2032
SEK
20 March 2012
1 June 2032
Annual
30E/360
Fixed
01/06/11
16.5
13.93
11,00,00,00,000
12,09,90,10,000

ISIN
Coupon
Bid
Ask
High
Low
Expiry
Currency
Issue Date
Maturity Date
Coupon Frequency
Day Convention
Coupon Type
Coupon From
Time to Maturity
Duration
Nominal Amount
Market Value

SE0004517290
2.250%
108.56
109.01
108.89
108.725
1 June 2032
SEK
20 March 2012
1 June 2032
Annual
30E/360
Fixed
01/06/11
16.5
13.93
11,00,00,00,000
12,09,90,10,000

2.2.10 SGB 1053

An chart depiction of all the maturities of the afore mentioned bonds-

Yield to Maturity & Yield Curve

A Yield curve is a line that plots the yield of fixed securities against the duration (length of
time) they have to run to maturity. Usually, a yield curve is plotted at a set point in time and
for bonds having equal credit quality. Therefore, the only differentiating aspect is the maturity
date. Yield curve is used as a benchmark of other debts in the market, for ex. lending rates,
mortgage rates etc. It is also used to predict changes in economic output and growth. Yield
curves are mostly of three types normal, inverted and flat. A normal yield curve is one in
which the securities with longer maturity have a higher yield compared to the shorter term
securities primarily because of the risks associated with time. An inverted yield curve is one
in which the shorter term yields are higher than the longer term ones could be a sign of
impending recession. A flat (also known as humped) yield curve is one where both long term
and short term yields are very close to each other this could also be a predictor of an
economic transition. The following are the yield to maturities of the bonds from 8th
December 2015 to the latest date of maturity.
Name
SGB 1050
SGB 1051
SGB 1052
SGB 1047
SGB 1054
SGB 1057
SGB 1058

YTM
-0.4541%
-0.3816%
-0.1329%
0.2258%
0.4978%
0.6839%
0.8876%
7

SGB 1059
SGB 1056
SGB 1053

1.1437%
1.6381%
1.9840%

Mapping these to a chart gives the following basic yield curve

YTM
2.5000%
2.0000%
1.5000%
1.0000%
0.5000%
0.0000%
-0.5000%
-1.0000%

To get a more refined version of the yield curve, we use the Nelson-Sieger Svensson method,
which uses 4 calibrators (1, 2, 3, 4) and 1 and 2. Using the Nelson-Sieger.Svensson
method on excel to give us the yield curve, we get the following yield curve:

Yield
NSS

During the calculation, the sum of the residuals was minimised at 3.69823703447441E-07
and following were the final values of the variables

Variable
1
2
3
4
1
2

Value
0.029115417
-0.03289979
-0.018561876
-0.048456567
1.291628789
3.077856591

Pricing a set of Cash Flows

We are expected to receive a semi-annual payment of SEK 1 million each for 22 periods
starting January 1, 2015 till July 1, 2025. We are to calculate the current value of these
payments. Also, given that the risk premium for these payments is equal to 1%. In our
calculation, we have considered the risk free rate return as 1.15% as this is the approximate
yield for an instrument that matures at around 2025. Therefore, the discount rate that has been
considered for this calculation is 2.15%. This rate is per annum and for our calculation, we
need to use a half annum period, which amounts to 1.069%. Based on the given inputs, the
current price of these payments is SEK 19,512,091. Alternatively, another approach is to
discount each payment with a different, corresponding rate of return corresponding to the
security of the respective time period and normalise those rates. Based on these inputs, the
current price of these payments of SEK 1 million each half year is SEK $19,593,560.

Hedging

Hedging is an investment that helps in mitigating the risk of any adverse price movement of a
security. Most frequently, a hedge consists in taking an offsetting position in a related
secutity. A perfect hedge eliminates In this section, we use two bonds to build a hedge of the
set of payments semiannual payments equal to 1 million SEK with an interest rate of 2.15%
per annum. The two bonds we have selected are SGB1058 (Coupon of 2.500% with YTM of
0.8876%) and SGB1053 (Coupon of 2.250% and 1.9840%). We also have to consider the fact
that while the payments from the cash flows in calculation 4 is semi-annual, the coupon
payments received are annual.
v0 is the series of payments (1 million SEK semi annually) and v 1 & v2 refer to 1 million
bonds of SGB1058 and SGB1053 respectively. The expressions for the present value of the
cash flows are:
(all numbers, except no. of bonds & slope, unless expressly mentioned otherwise are in million)

v0(r) = [1/(1+r)] + [1/(1+r)2] + [1/(1+r)3]+[1/(1+r)22]

v1(r) = [2.5/(1+r)] + [2.5/(1+r)2] + [2.5/(1+r)3].+ [2.5/(1+r)20]
v2(r) = [2.25/(1+r)] + [2.25/(1+r)2] + [2.25/(1+r)3].+ [2.25/(1+r)]
The expressions for the slopes of the bonds are:
s0(r) = - [1/(1+r)2] - [(1 x 2)/(1+r)3] - [(1 x 3)/(1+r)4]..+ - [(1 x 22)/(1+r)23]
s1(r) = -[2.5/(1+r)2] - [2.5 x 2/(1+r)3] - [2.5 x 3/(1+r)4].- [2.5 x 20/(1+r)21]

s2(r) = [2.25/(1+r)2] + [2.25/(1+r)3] + [2.25/(1+r)4].

The present values and slopes at a yield of 1.069% are

V0 = 18.2462 | s0 = -194.2692
V1 = 42.1283 | s1 = -411.9543
V2 = 33.0057 | s2 = -279.0782
For the hedge, we need the following equation to hold true.
s0 + a1s1 + a2s2 = 0
Solving for a2, we obtain:
a2(a1) = [(-s0 + s1a1)/s2] = - 0.6961 - 1.4761a1
Finally, a plot of a2 (a1) is plotted as below.
1.2

0.8

0.6

0.4

0.2

10