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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

0 A A A A A A A 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