Fixed Income Risk and Return

shanky · March 21, 2015, 8:10pm

Hi All,

I’m confused while reading study session 16 page no. 106. While calculating the PV for a bond sold prior to maturity.

For e.g YTM=7%,N=3(held to maturity),Coupon rate=6%(annual), FV=1000, PV comes up to be=973.76

and when the same bond is having 2yr holding period instead of using N=2 they have done the calcualtion using N=1

Can some one help me with this.

Thanx

_Oscar · March 21, 2015, 8:25pm

I suppose they ask for the price at selling (=price in N=2).

shanky · March 21, 2015, 8:50pm

my cofusion lies in , when the the bond is having 2 yr holding period the N=2(my assumption) but in the schweser it is showing as N=1. How is this justified?

Chippychips · March 23, 2015, 8:17am

Hope I can put this in a way thats easy to understand, I haven’t reached this section but was interested in the question, (this is my next study session anyway)

Using the 2 years is not wrong by calculating from the purchase price upto sale price in year 2 we have:

N=2 PV=-973.76 PMT=60 I/Y=7 Then compute FV to get 990.65

the way they have explained it, calculating backwards from the Maturity price ($1000) in year 3 back to selling price in year 2 (ie. the person buying the bond after 2 years will only have 1 year left of the bond)

N=1 (3 years - 2 years) FV=1000 pmt=60 I/Y=7% Compute PV=-990.65

Hope this helps and is right, its the only way i can make sense of it. Read up a little on carrying value of a bond it might help, because thats all they calculating, the price of a bond during its ‘life cycle’.

Good Luck

_Oscar · March 23, 2015, 8:49am

The present value of a bond sold prior to maturity is simply the present value of the cash flows of the remaining years until maturity. This in 1 year (N=1) in the example. Until maturity there would only be one cash flow left (last coupon plus face value). The present value of this cash flow is the price a potential buyer would be willing to pay.

It doesn’t matter how long you have been holding the bond before selling it. I advise you to draw a timeline with the corresponding cash flows and it should immediately become clear.

Best, Oscar