financial markets and institutions week 3 slide
TRANSCRIPT
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
1/47
1
Week Three
Mathematics of Finance Revisited
Short, medium and long-term debt Structure of the money markets.
Interest bearing securities
Discount securities. Securitisation
Viney Chapters 8, 9 and 10
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
2/47
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
3/47
3
Introductory concepts
Financial market calculations operate according to aset of market conventions
Example: interest rates are quoted per annum andto 2 decimal places
Example : coupon payments on fixed interestsecurities are usually 6-monthly. Australian
Government bonds always pay interest and matureon the 15thof the month.
Example : British empire countries use 365 days in ayear. USA/Euro countries use 360 days
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
4/47
4
Students Please Note
If you are not longer familiar with these
concepts review the examples in the text. It is assumed that you can manage these
calculations.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
5/47
5
Introductory concepts - continued
Nominal interest rate: the annual simple
percentage rate of return taking no accountof compounding.
Effective interest rate: the annual percentagecumulative rate of return after including
compounding effects You are expected to know how to calculate
these!
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
6/47
6
Introductory concepts - continued
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
7/477
Introductory concepts - continued
Securities with maturity less than one year
are quoted on a per annum basis adjustedfor the number of days to maturity
Example: a 90-day bill with 9% pa. nominal
rate has a per period rate of:
0.09 x 90/365 = 0.0222 (or 2.22%)
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
8/478
Discount securities
Definition: a security sold at a price below its facevalue. There are no other cash flows.
The profit to the investor is the difference betweenthe face value (F) and the price (P). It is known asthe discount.
eg: an investor buys a bank bill with face value$100,000 for $98,000. The discount is F-P = $2000.This is also the expected return.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
9/479
Holding period yield (HPY)
HPY is the yield on securities sold in the secondarymarket prior to maturity
Short-term money market securities (e.g. T-notes)may be sold prior because Intended short-term management of surplus cash held by
investor
The investors cash flow position has unexpectedly changedand cash is needed
A better rate of return can be earned in an alternativeinvestment
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
10/4710
Holding period yield (HPY) (cont.)
The yield to maturity is the yield obtained by
holding the security to maturity The HPY is likely to be different from the
yield to maturity
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
11/47
11
Holding period yield (HPY) (cont.)
The HPY will be
Greater than the yield to maturity when themarket yield declines from the yield at purchasei.e. interest rates have declined and the price ofthe security increases
Less than the yield to maturity when the marketyield increases from the yield at purchase i.e.interest rates have increased and the price of thesecurity decreases
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
12/47
12
Short-Term Debt cont
Commercial Bills
A bill of exchange is a discount security issuedwith a face value payable at a future date
A commercial bill is a bill of exchange issued toraise funds for general business purposes
A bank-accepted bill is a bill issued by acorporation that incorporates the name of a bankas acceptor
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
13/47
13
Short-Term Debt cont
Calculating priceyield known
A company decides to fund it short-term inventoryneeds by issuing a 30-day bank-accepted bill with aface value of $500,000.
Having approached two prospective discounters, thecompany has been quoted yields of 9.52 per centper annum and 9.48 per cent per annum.
Which quote should the company accept, and whatamount will the company raise?
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
14/47
14
134.23$496
365
30*0948.1
1*000,500
or
118.04$496
365
30*0952.1
1*000,500
Short-Term Debt cont
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
15/47
15
Short-Term Debt cont
Calculations cont In the previous example a company issued a 30-day bank-
accepted bill with a face value of $500,000.
The bill was discounted at a yield of 9.48 per cent per annum,representing a price of $496,134.23.
After seven days the discounter sells the bill in the short-term
money market for $497,057.36. Assume the bill is not traded again in the market, calculate the
yield to the original discounter and to the holder at maturity.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
16/47
16
Calculating yield (cont.)
Yield to original discounter:
Yield to holder at maturity:
9.70%7
50036
134.23496
134.23)496057.36(497
9.39%23
50036
057.36497
057.36)497000.00(500
Short-Term Debt cont
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
17/47
17
Long-Term Debt
Repayment may be Interest only during term of loan and principal
repayment on maturity Amortized loan (credit foncier loan)
periodic loan installments consisting of interest dueand reduction of principal
Deferred repayment loan loan installments commence after a specified period
related to project cash flows, and the debt is amortizedover the remaining term of the loan
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
18/47
18
Long-Term Debt cont
Calculations: Fixed Interest Securities
Price of a fixed interest bond at coupon date The price of a fixed interest security is the sum of
the present value of the face value and thepresent value of the coupon stream
niAi
n
iCP )1(])1(1[
(Example also in Viney 8.10)
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
19/47
19
Long-Term Debt cont
Calculations: Fixed Interest Securities (cont.)
Price of a fixed interest bond at coupon date(cont.) Current corporate bond yields in the market are 8 per cent per
annum.
An existing corporate bond with a face value of $100,000, paying10 per cent per annum with half-yearly coupons, and exactly sixyears to maturity, would be sold at a price of:
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
20/47
20
Calculations: Fixed Interest
Securities (cont.)
a
b
9385.07$10
925.37$46459.70$62Price
925.37$46
]0.04
120.04)(11$5000[coupons
plus459.70$62
120.04)000(1$100valueface
PV
PV
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
21/47
21
On The Calculator
Make sure payments are set to 1 per year
N = 6 * 2 = 12 I/Yr = 8/2 = 4
PMT10%x100,000/2 = 5,000
FV = 100,000 PV = 109,385.07
Why is the PV negative?
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
22/47
22
Relationship Between Price and
Yield
The relationship between price and yield is
inverse Thus as the yield of the security rises, the
price falls
As the yield of the security falls, the price
rises
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
23/47
23
Relationship Between Price and
Yield cont
An example;
Calculate the price of the following security(assume $1,000 face value)
90 day bank bill at a yield of 4.5%
recalculate at a yield of 4.25%
180 day bank bill at a yield of 4.50% Recalculate at a yield of 4.25%
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
24/47
24
Relationship Between Price and
Yield cont
Now calculate the percentage change in
price of both the securities Which has had the bigger change?
Why?
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
25/47
25
Term/Yield 90 Days 180 Days
4.50% $989.03 $978.29
4.25% $989.63 $979.47
Per Cent Change 0.061% 0.121%
Relationship Between Price
and Yield cont
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
26/47
26
Relationship Between Price and Yield
on Bonds
Another example;
Calculate the price of the following security(assume $1,000 face value)
Coupon 6.5%. Maturity 5 years. Current yield4.5%
recalculate at a yield of 4.25% Coupon 6.5%. Maturity 10 years. Current yield
4.5%
recalculate at a yield of 4.25%
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
27/47
27
Relationship Between Price and Yield
on Bonds cont
Calculate the percentage change in price forboth
Which has had the bigger change?
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
28/47
28
Term/Yield 5 years 10 years
4.50% $1088.66 $1159.64
4.25% $1100.40 $1181.75
Per Cent Change 1.0747% 1.915%
Relationship Between Price and
Yield on Bonds cont
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
29/47
29
Tender vs Tap System
Tender
Issuer announces the amount and terms underwhich they wish to issue new securities
Interested parties have a set time by which theymust state how much and at what price they areprepared to buy the new securities.
Highest bidder application is filled. Allocationcontinues to bidders in order of price until allnew issue is allocated.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
30/47
30
Tender System cont
Objective of bidder
To obtain all new securities required withoutpaying too much
To ensure that the price paid is so low that anallocation is not received
Objective of issuer To receive as high a price as possible
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
31/47
31
Tender System cont.
Advantages
Receive all funds required at a market price Disadvantages
No control over price paid (unless a reserve priceis set or the issue is underwritten)
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
32/47
32
Tap System
Tap System
Issuer announces the amount, terms and priceatwhich they will issue new securities
Interested parties have a set time by which theymay make application for the securities
All allocations are filled as long as the window isstill open and that there are securities to beissued.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
33/47
33
Tap System cont
Advantages
Seller sets the price of the security
Disadvantages
If the set price and terms are not attractive theissuer may not receive all the funds required.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
34/47
34
Securitization
Securitized bonds: a packaging of smallincome-generating assets into a large fixedinterest (asset-backed) security
Example: housing loans
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
35/47
35
Securitization - continued
How securitization works
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
36/47
36
Securitization - continued
Enhancement: increases marketability improving onthe risk of a security and increasing its credit rating
Involves various steps, for example Primary Mortgage Insurance
Pool Insurance
Maturity refinance
Cash flow guarantees
But will reduce return due to cost of guarantees
See Viney p 417- 420 for more information
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
37/47
37
Securitization - continued
Why securitize?
- better risk management
- diversify funding base
- balance sheet management
- product diversification
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
38/47
What Role has Securitisation
Played in the Current GFC?
38
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
39/47
39
In Conclusion
In this lecture we have
Reviewed the pricing of securities
Discussed the important relationship betweenprice and yield
The process by which fixed income securities arefirst issued
The process and rationale for securitization.
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
40/47
40
Next Week - Week Four
Interest Rate Markets continued
Market participants and reasons for trading Price behaviour
The impact of maturity date
The risk and term structures of interest rates
Trading strategies and rate forecasting
Viney Chapter 13
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
41/47
Assignment
Gives a practical insight into the mechanicsand operations of the
Foreign exchange
Equity and
Interest rate markets
By trading futures contracts in each market.
41
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
42/47
Futures Contracts
Foreign exchange as traded on the CME.
Each contract has a face value of AUD100,000
ASX S&P 200 SPI as traded on the ASX
Each contract has a face value of $25 * points
Interest rates (bonds and bank bills) as
traded on the ASX Bank bill face value $1m
Bond face value $100,000
42
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
43/47
Limits
Closing position not to exceed 50 contractsat any time.
Limit of 1 trade per week.
Limit of 1 zero position
43
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
44/47
Short Selling
How can I sell something I dont own?
44
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
45/47
Reporting
Stage 1
Weekly iJournal in MyECU blog.
Team mates to comment on your blog
This should be the start of your final writtenreport.
Stage 2 Weekly in class discussion by sector
One person to write up notes in blog in MyECU
45
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
46/47
Stage 3
Final report
Part 1Report to the Board of Directors (28/35) Cover letter
Executive summary
Theory
Weekly discussion based on your blogs
Part 2Assessment of your assignment (3.5/35)
Part 3Reflection (3.5/35)
46
-
8/11/2019 Financial Markets and Institutions Week 3 Slide
47/47
Questions