 Fixed Income

What is fixed income?  When you hear fixed income what do you think about?  A type of investing or budgeting style for which real return rates or periodic income is received at regular intervals at reasonably predictable levels

Who uses fixed income?  Retail investors  Retirement accounts  Pensions

Types of Fixed Income  Annuities  Tax-Exempt Bonds  Taxable Bonds  MBSs, CDOs, CMOs, MSRs

Annuities  Sold by financial institutions  Accept and grow funds  Payment later  Accumulation phase  Annuitization phase

Structure  Principal + Accumulated Returns  Guaranteed  Index Based  Tax Benefits

Present Value  An individual wants to determine how much money she would need to put away to have $100 on year from today  What we need?

PV of Annuity Formula 0AAA A A AA A F i Discounting to Present Time

FV of Annuity

Present Value of an Annuity  Use Future Value to get Present Value  Discount

Present Value of an Annuity  Substitute in the Future Value

Bonds  A debt investment in which an investor loans money to an entity which borrows the funds for a given period of time at a variable or fixed interest rate  Used to finance capital expenditure  Owners referred to as debtholders or creditors of the issue

Components of Bonds  Interest rate (Coupon)  Principal  Maturity Date  Issue Price  At par  Face Value  Intrinsic Value

Types of Bonds  Zero Coupon  Convertible  Callable  Non-Callable

Zero Coupon  No regular coupon payments  Issued at a discount to market  Market price converges to face value

Convertible  They are bonds with an embedded call option  Allows bondholders to convert debt into equity  Attractive conversion

Callable  Company can call back bonds from debt holders  Interest rate decrease  ReFi  Usually traded at a premium

Features of Bonds  Credit Quality  Yield  Pricing  Duration

Credit Quality  Each bond has a credit rating  Indicates likelihood of default  Moody’s, S&P, and Fitch

Ratings

Yield  Amount of return an investor will realize on a bond  Nominal Yield  Current Yield  Yield Curve

Treasury Yield Curve

Bond Pricing  Premium, Discount, or Par  Calculating max you want to pay  Fundamentally: the price of a bond is the sum of the present values of all coupon payments plus the present value of the par value at maturity

Pricing Formula (Basic)

Pricing Formula (Annuity Incorporation)

Duration  Measures price sensitivity to change in interest rates  Longer maturity = more sensitive  Expressed as a number of years  Rising interest rates = falling bond prices  Falling interest rates = rising bond prices

Duration Formula

Types of Bonds  Treasuries  TIPS  Municipalities  Sovereign  Corporate  Many More…..

Bond Market Size