SECURITY ANALYSIS

TOPIC:
BASIC BOND ANALYSIS

INTRODUCTION
1.
2.
3.

It is the long-term debt instruments issued

by the organization's or Government to
raise funds.
Interest bearing note.
It is also known as acknowledgement to
debt.

TYPES OF BONDS

1.

Mortgage-Bonds.
(security must deposit)

2.

Debenture Bonds.
(security not required)

PRICING A BOND
1.
2.

Maximum price that one is willing to pay

is known as price of bonds.
The price of a bond is the present value of
its expected cash flow.

SINGLE CASH FLOW

1.

A lump-sum amount expected some future

date.

DISCOUNT RATE
1.
2.

i is also referred to as the discount rate.

Using this i we find out the value of
future cash flow at present.

MULTIPLE CASH FLOW

1.
2.
3.
4.

Bonds have more than one cash flow.

Each cash flow is discounted in order
find the present value.
Common practice is bond markets is
discount using a redemption yield.
Bongs are issued semi-annually.

to
to

DIRTY & CLEAN PRICES

1.
2.
3.

DIRTY PRICE = With Accrued

CLEAR PRICE = Without Accrued
Price in the market are usually on a clean
basis but settled on a dirty basis.

RELATIONSHIP BETWEEN
PRICE AND YIELD
1.
2.

Direct relationship between the price of

bond and its yield.
Inverse relationship between YTM and
price.

YIELDS AND
YIELD CURVES
1.

The interest rate provided by market is

calculated to find IRR.

MONEY MARKET YIELDS

1.

Money market yields are quoted on a

different basis and therefore in order to
compare short-term bonds and money
market instruments it is necessary to look
at them on a comparable basis.

USES OF YIELDS CURVES AND

YIELD CURVES THEORIES
1.
2.
3.
4.

To analyzed money market yield curves

are utilized.
Money market yield curves defines
graphically structure of yields.
It is helpful for Government use.
It shows that to increase investment, yield
and risk increase.

FLAT YIELD
1.

It does not take into account accrued

interest; nor does it take into account
capital gain/ loss (i.e. it assumes prices
will no change over the holding period);
nor does it recognize the time value of
money.

SIMPLE YIELD
1.

This is slightly more sophisticated

measure of return than flat yield, which
takes into account capital gain, it grows on
linear fashion.

(YTM)
REDEMPTION YIELD
1.

It is utilized to find out that either coupon

interest provided by the market is in favor
of the organization who is investing or not.

SPOT RATE AND

ZERO COUPON CURVE
1.
2.

Spot rate is the current rate of market.

Zero coupon curve means, bonds in which
no interest, like price bond etc.

FORWARD ZERO COUPON

YIELD (Implied forward rate)
1.

Forward spot yields indicate the expected

spot yield at some date in the future.

REAL IMPLIED FORWARD

RATES
1.

Real implied forward rates can understand by

using this formula.

(1 + nominal forward) = (1 + real forward)

(1 + inflation forward)

PAR YIELD
1.

It is the coupon that a bond would have in

order to be priced at par, using the zero
coupon rates in the discount function.

Debt Management Product

Treasury Bills:
1.T-bills debt instruments with maturities of one year or less
2.Treasury bills are low-risk investments with a broad and
liquid secondary market.
3.Issued at discount to their face value.
4.T-bills are free of default risk, they generally have lower
yields
5.T-bills are purchased by investors at a weekly auction at
less than face value and are redeemed at maturity at face
value.
6.The difference between the purchase price and the face
value of the T-bill is the investor's return.

Conventional Bond

Conventional bonds have a fixed coupon and

redemption payment at maturity.
Coupon are usually paid annually or semiannually.

This bond can be thought of as offering a nominal

yield that takes into account the real yield and
anticipated inflation:

Real yield = Real return + Risk premium

N = R + Pe + RP
The risk premium is the amount of market demands
for unanticipated inflation.
High inflation = greater risk premium

Floating Rate Bonds

1.

2.

3.

Floating-rate bonds, take away the risk that fixedincome bonds bear. As their name implies, floatingrate bonds pay different rates of interest depending
on prevailing rates in the bond market.
The bonds generally refer to a benchmark market
rate; when that rate rises, so will your interest
payments. But if the rate falls, then your interest
checks will go down as well.
The price of floater depends on the spread above or
below the prevailing rate

Index Linked Bond

A bond in which payment of income on the

principal is related to a specific price index,
often the Consumer Price Index.
This feature provides protection to investors
by shielding them from changes in the
underlying index. The bond's cash flows are
adjusted to ensure that the holder of the bond
receives a known real rate of return.

Convertible Bond

A convertible bond is a bond that gives the holder the right to

"convert" or exchange type of security for another, e.g. short
term to long term, fixed to floating or indexed.
The exchange feature of a convertible bond gives the right for
the holder to convert the par amount of the bond for common
shares a specified price or "conversion ratio".
For example, a conversion ratio might give the holder the right
to convert $100 par amount of the convertible bonds of
Ensolvint Corporation into its common shares at $25 per
share. This conversion ratio would be said to be " 4:1" or "four
to one".

The interest paid by a bond is called the coupon or coupon

amount.
Zero coupon bonds do not make regular interest payments to
the bond holders.
Zero coupon bonds, also sometimes known as "Strips," do
not have regular interest payments.
Zero coupon buyers purchase the bond at a significant
discount to the face value at maturity. The amount of
interest to be earned is the difference between the current
price and the face amount.

zero coupon bonds are issued with long-term

maturities--10 years or longer.
Zero coupons are useful for planning and
providing money for a future event, such as
paying for college or starting retirement.