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Fixed incomeBy Shivgan Joshi

http://stockcreditfinancecfa.blogspot.com/

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Caution

Lots of assumptions

In many places TVM is ignored

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Developing Intuition

Cash flows:

20121 Jan=-100 20131 Jan=10

20141 Jan=0

20151 Jan =100

IRR=? Huge approximation = 3.33% Geometric Arithmetic

Bank fixed / depending project

US(1.25%) vs India(10%)

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NPV vs. PV

Net means minusing and removing

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Example

Individual a stand alone company and not bank

This is an internal matter

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IRR

Internal

Rate ofReturn

Inside, in the system, in our model = internet

-100 (2012)-- 10(2013), 110(2014) ?? 10%

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Price vs Yield

100 110 (IRR=10%) Market Interest rate of similar risk instrument is

8% Market rate for similar is 12% 31 Dec Party = Market Rate was 8% 1 Jan, RBI upheaval = 12% Market rate is not under your control, that

means bond price is also not our control We will try to sell to other person and decide the

price

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Read this on simply simple

PPT of these people are also very good

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Yield

Market rates of return on similar instrument Sometime taken as Risk free US treasury bond +

spread

100 120 Ours (as market interest rate /yield was20%) this is our locked cash flows at 31 dec

100 115 Market (now market rate changed to 5%) at1 jan

Then we will sell our instrument at 105 Smartey No arbitrage

Price of Portfolio increased

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Equilibrium and Adjustments

Price Yield adjusts as things so that no one can

make profit Everything remains fair and no on is at loss

Price changes with Yield changes

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Basics

Fixed Future payments vs interest rates in

market CF: 10, 110.. Damn Fixed

Yield / Market interest rate (raw definitions)10%--- 20%

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Yield vs IRR Same Risk Internal thing

Yield (entire universe with similar risk

instrument)

IRR

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Duration Intuition

Pay back period vs discounted pay back period

10,10,10,100 (Assume 90Rs bond) what ispayback period?

Bond Price vs Face Value

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Duration One of the things that requires patience Macaulay Duration vs. Modified duration

Weight time vs. Sensitivity

Example fromWikipedia

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Convexity

Parameter for right adjust for change in yield to

price

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References

Wiki