Attribution Non-Commercial (BY-NC)

Просмотров: 37

Attribution Non-Commercial (BY-NC)

- Partial Income Statement for Manufacturing Company
- Notes Chapter 4 FAR
- 2012 FAR Content
- FAR Material Cross Reference
- 2012 Edition Becker - Financial Final Review
- financial analysis
- Module 1 - Handout 5e[1]
- FAR 1 Notes
- accounting
- Accounting and Finance
- FAR 2 Notes
- financial statement
- FAR Study Plan
- Financial Accounting 123
- FAR430 (1)
- FAR 4 ASSIGNMENT
- FL087-Accounting Concepts and Principles Study Manual
- MC Questions Ch 24-1
- FAR250_260_FAC250_391
- Outline

Вы находитесь на странице: 1из 10

Pricing Convention:

• Priced at a discount from par or face value using the “true discount” formula and a 360-day

count. The “true discount” formula is just simple interest calculation in reverse

• Following market convention, how much of the annual yield you will actually earn is

directly proportional to the number of days (tenor) you are invested in a 360-day year. That is,

tenor

interest income is computed as: amount invested x annual yield x

360

• Final tax of 20% is paid upon purchase, i.e., front-loaded tax

Example:

Simple interest means that if you were to invest P 97,534.54 for 182 days at a quoted (before tax)

annual yield of 5%, you will earn an interest income of:

182

97,534.54 x 0.05 x = 2,465.46

360

So, after 182 days, you can expect to receive a total of P100,000 = 97,534.54 + 2,465.46

Investing in treasury bills means buying a future value (the face or par value). In our example, this

is the P100,000 we expect to receive in 182 days. Hence, T-bills are sold at a discount from par,

with the discount constituting your interest income. The formula for the discounted price

(97,534.54 in our example) is just simple interest calculation in reverse:

D = discounted price = =

360 + yield x tenor 360 + Y x T

Philippine tax laws however impose a front-loaded final tax of 20% on interest or discount income.

Hence, the T-bill’s selling price (S) should include the tax:

Notice that if the tax had been back-loaded as is the case with bank deposits, our after-tax yield

would have been: 4% = 5% (1 – 0.20). Paying the tax up front means that we lose interest that we

could have earned on the tax payment. Hence, our after-tax yield is only:

1,972 .37 360

3.98 % = 98 ,027 .63 x

182

UP CBA

Simplified T-Bill Formulas for Selling Price, Face Value and Yield

Selling Price

The multiple steps involved in determining a T-Bill’s selling price inclusive of tax can be simplified

in one formula:

F x (360 + Y x T x 0.2)

S=

(360 + Y x T)

Given that face value is fixed, price is inversely related to yield, consistent

with the present value principle that the higher the discount rate, the lower is

present value.

At a higher yield of 6%, the same treasury bill should sell at a lower price of 97,644.68.

And at a lower yield of 4%, this treasury bill should sell at a higher price of 98,414.29.

S x (360 + Y x T)

F=

(360 + Y x T x 0.2)

Many dealers allow clients to set the exact amount they wish to invest. For example, investors often

roll over all of the maturity value, i.e., “maximize” their investment. This could result in maturity

values that are fractions of the face values that T-Bills are typically denominated in (which are

round multiples of P1 million). This simply means that the investor will be part-owner of a mother

certificate with a face value that is a round multiple of P1 million.

UP CBA

Some dealers prefer to quote after-tax yield to suit client preferences. To determine the equivalent

gross yield for comparability with yield quotations of other dealers:

360 x y

Y= where y is the after-tax yield

288 – y x T x 0.2

Simple buy-and-hold strategies involve a choice of tenors which are then held to final maturity.

Selling before maturity is not a deliberate part of the investment strategy.

In general:

• If rates are expected to increase, buy/invest in the short tenor

• If rates are expected to decrease, buy/invest in the long tenor

Suppose an investor has P100,000 available to invest for 203 days. Today's spot rates are 5.75% for

91-day T-bills, 5.85% for 112-day T-bills, and 6% for 203-day T-bills. The investor is considering

two investment options: initially invest for 112 days, then reinvest for 91 days; and an outright

purchase of a 203-day T-bill. Choosing the short tenor means accepting the lower rate but he

anticipates the 91-day T-bill rate to rise to from today’s spot rate to 6.4%. The shorter tenor may be

more profitable since he can subsequently reinvest at a higher rate.

The maturity value of a P100,000 112-day T-bill invested at today's spot rate is:

= P101,450.72

(360 + 0.0585 x 112 x 0.2)

which maturity value, if reinvested for 91 days at the expected rate of 6.4%, yields :

= P102,759.48

(360 + 0.064 x 91 x 0.2)

= P102,688.47

(360 + 0.06 x 203 x 0.2)

Hence, based on the rate expectation, choosing the short tenor will earn an additional P71.01, and a

203-day yield of 6.16%, 16.0 basis points more than the 203-day spot rate of 6%.

UP CBA

Clearly, choosing the short tenor would yield more only if the 91-day rate increases to a level

sufficient to offset the term premium in spot rates, i.e., the 15 basis points that the spot 203-day rate

of 6% exceeds the spot 112-day rate of 5.85%. This "break-even" rate is called the FORWARD

RATE. In this case, the 91-day forward rate is 6.052%.

These transactions illustrate a decision to invest cash. However, the same considerations apply in a

choice to swap tenors, e.g., replacing a treasury bill of a short tenor with a T-bill of a longer tenor in

anticipation of a decline in interest rates.

The Implied Forward Interest Rate

The forward rate implied in the spot rates of two unequal tenors is illustrated below. Y1 is the annual

yield of the shorter tenor while Y2 is the annual yield of the longer tenor. The forward rate F2 is that

equivalent annual yield that will result in equal terminal values at time N2, where the maturity value

of the short tenor is ‘reinvested’ at F2 to from time N1 to time N2.

0 N1 N2

Y1 F2

Y2

In the case of T-bills, the implied forward rate can be determined using the formula:

F2 =

T x (M1 – 0.2 x M2)

M1 = maturity value of the short tenor

T = tenor corresponding to the forward rate (interval between N1 and N2)

(the formula assumes the same amount is invested at time 0 for the two tenors)

C x 360

F2 = where C = (M2/M1 – 1)

T x (0.8 – 0.2 x C)

UP CBA

In the buy-and-hold example, the forward rate was viewed as the “break-even” rate between the

two strategies: the certain outcome for the long tenor, versus the uncertain outcome if the short

tenor is chosen, brought about by the uncertainty over the market yield at time N1 which yield will

determine the strategy’s final payoff at time N2.

The forward rate is also often referred to as the “lock-in” rate. The long tenor is in effect equivalent

to two sequential placements: the first at the spot rate Y1, and then a reinvestment to N2, but at an

assured rate. Choosing the long tenor over the short tenor eliminates the uncertainty about the

reinvestment yield by locking it in at the forward rate.

Yet another way to view the forward rate is that it reflects the market’s expectations about future

interest rates; specifically, the yield for tenor T expected to prevail at time N1. How so?

In the buy-and-hold illustration, the investor is expecting the 91-day T-bill rate to rise from today’s

spot rate of 5.75% to 6.4% in about 112 days time. He finds that investing in the shorter tenor and

subsequently reinvesting at the expected higher rate will be more profitable than buying outright a

203-day T-bill. In fact, he estimates that for as long as the 91-day T-bill rate will rise to a level

higher than the forward rate of 6.052%, a strategy of investing in the short tenor promises a higher

expected return.

Suppose other investors share his view that interest rates, particularly the 91-day T-bill rate, will

rise. These investors will likewise favor the shorter tenor, or if they are currently holding long

tenors, may even switch out of their current positions into the shorter tenors. If there are enough of

these investors, their transactions will tend to increase the demand for the shorter tenor, and reduce

that of the longer tenor. This will push up the price of the short tenors, i.e., reduce their yield. The

reduced demand for longer tenors will in turn lower their price and increase their yields.

As yields adjust in this manner, the forward rate must rise. In short, the forward rate will eventually

adjust to reflect market consensus on future interest rates.

But is the forward rate an unbiased estimate of market consensus about future interest rates? Not

quite, because other factors systematically affect the yield curve. For one, we know that the present

value of more distant cash flow is more sensitive to discount rate changes than that of nearer cash

flow. This means that for fixed-income securities, the longer the tenor of bills/bonds, the greater

their price sensitivity to changes in yields, i.e., the greater the price risk. And since investors

demand a premium for risk-taking, longer tenors will generally command higher yields than shorter

tenors, even in the absence of expectations of interest rate changes.1 Hence, the term premium

reflects both market expectations about future interest rates and a risk premium.

1

That’s why the yield curve is normally upward sloping.

Credits to Prof. R.C. Ybañez

UP CBA

We can safely say that the forward rate reflects market consensus about the future level of interest

rates, but we would need a more complex model of the yield curve to isolate that from the other

effects on the yield curve, e.g., the price risk premium.

Riding the yield curve is an investment strategy that requires selling T-bills before final maturity. It

utilizes the positive slope of a normal yield curve to enhance investor returns by taking advantage of

price increases (yield decreases) as the T-bill’s remaining tenor declines over the investor’s holding

period.

An investor buys a T-bill with a tenor (say 273 days) longer than his planned holding period (say

182 days), and then sells on the day cash is needed (day 182) when its remaining tenor (91 days) is

now shorter. Riding down the yield curve in effect means riding up the price curve – buying at a

high yield (lower price) and eventually selling at a low yield (high price).

To illustrate, suppose the current yield curve has the following spot rates: 91 days at 5%; 182 days

at 5.5%; and 273 days at 6%.

− 965,184.12 6% 1,000,000

990,015.09 5% −1,000,000

The investor’s final cash flow will be:

− 965,184.12 990,015.09 for a yield of 6.402%

− 965,184.12 5.5% 986,535.37

Tail-end gapping generates a net advantage of P3,479.72, or an additional 90.2 basis points. Once

again, the break-even rate between the two strategies is the (91-day) forward rate.

• a stable, positive yield curve. The steeper the yield curve, the better. Stability is of course

not guaranteed and hence, the strategy bears the risk that the short tenor’s rate will rise and

prices will fall. Note that the buy-and-hold alternative strategy has no such price risk.

UP CBA

• transactions cost. The investor has to sell the T-bill and will incur transactions costs in the

form of a dealer’s spread. For the same tenor, e.g., 91 days, a dealer normally quotes buying and

selling rates – buy quotes at a higher yield (low price) and sell quotes at a lower yield (high

price). The yield differential is the dealer’s spread.

Spread Trading

Spread trading or rate anticipation swaps are relatively more complex and more risky strategies, but

can also offer greater rewards. Previous examples focused on yield changes of a single security.

Spread trading strategies focus on spread changes, which can be between tenors of the same

security class, two security classes of the same tenor, two currencies of the same tenor and security

class, etc.

The spread adjustment could occur via yield changes in one, or both of the securities. Thus, spread

trading strategies generally involve simultaneous buying (long) and selling (short) positions. The

investor buys the security whose price is expected to rise (yield to fall) and sells the security whose

price is expected to fall (yield to rise).

The first Gulf war in 1990 led to high volatility in oil prices and in FX and T-bills yields. The Dec.

28 yield curve showed a negative spread between short and long tenors: 91-day yield was at

35.154%, 182-day yield at 35.593%, and 31.112% for 364-day T-bills. Many expected the spread to

normalize once the Gulf crisis was resolved: the yield for the short tenor should fall relative to the

long tenor. A spread trading strategy would involve the following:

808,560.83 31.112% − 1,000,000

− 808,560.83 35.593% 920,912.94

By the second week of January, the US coalition had won the war and global markets had begun to

normalize. Yields adjusted to 31.909% for the 168-day tenor and 31.546% for the 350-day tenor.

The investor can already profitably unwind his positions at this point.

Credits to Prof. R.C. Ybañez

UP CBA

825,426.21 31.909% − 920,912.94

− 812,230.58 31.546% 1,000,000

0 13,195.63 0 0

Note that over the 14-day holding period, the long position in 6-month T-bills resulted in an annual

yield of 67.4%, while the short position in 1-year T-bills resulted in a yield of −14.605%. The risk

of course is that the spread will move in the opposite direction.

The price-yield relationship that is the basis for active asset management applies as well to

liabilities. Asset-liability investment strategies typically involve a deliberate tenor mismatch, or gap,

between assets and liabilities.

Suppose interest rates are expected to rise. We’ve seen that investors will prefer short tenors to be

able to reinvest at the higher rate, and to avoid the price loss from long tenors. On the liability side

however, we would prefer the long tenor to be able to lock in borrowings at today’s low interest

rate. This type of tenor or maturity mismatch is called a ‘positive gap’.

A ‘positive gap’ exists if the amount of assets that will mature or will be repriced exceeds the

amount of liabilities that will mature or will be repriced over a particular time period. A gap is

necessarily defined over a particular time frame, e.g., over the next 12 months, as the type of gap

could vary over different time intervals.

A ‘negative gap’ is the reverse, maturing (or repricing) assets are less than the maturing (or

repricing) liabilities. When interest rates are expected to fall, investors prefer to invest in long tenors

and borrow in the short tenor. Note that ‘riding the yield curve’ is a form of negative gapping.

A zero gap or ‘square position’ means there is no mismatch in assets and liabilities.

Gapping strategies seek to maximize the profit potential from expected interest rate or yield

changes, but it can also be quite risky. A positive gap is driven by expectations of rising interest

rates, but if rates move in the opposite direction, declining interest rates would mean the investor is

forced to reinvest in low yield assets and may end up locked in at high borrowing costs. Note

UP CBA

further that if the yield curve is positively sloped, a positive gap means that the investor’s asset-

liability position will initially carry a low or even negative spread.

Effective execution of gapping strategies requires that both assets and liabilities are in relatively

liquid securities. Hence, gapping is typically exercised by financial institutions that have ready

access to financial markets and have the ability to quickly reverse or unwind asset-liability positions

that have become exposed to changing interest rate directions.

Financial prudence suggests that non-financial corporations, which have mainly illiquid real assets,

should generally aim for maturity matching.

Illustration of Gapping

We illustrate the possible outcomes of gapping strategies for a financial institution (FI). Many FI’s

earn a good part of their profits by lending/investing, earning a spread over borrowed funds. In this

illustration, we assume a normal spread of 400 basis points and a conservative debt-equity ratio of

4:1. To simply the arithmetic, we assume zero taxes and simple interest calculation over a 364-day

year. The FI expects interest rates to drop by 200 basis points in six months time:

182 15% 11% 13% 9%

364 17% 13% 15% 11%

Balance Sheet Income(Expenses) ROE

Consider first the full year results of a square position, e.g., 1-year loans and borrowings:

Borrowings 80,000 (10,400)

Equity 20,000 6,600 33.0%

Given the expectation of declining interest rates, a more aggressive FI will go for a negative gap,

i.e., 1-year loans and 6-month borrowings:

Borrowings 80,000 (8,198)

Equity 20,000 8,802 44.0%

UP CBA

On the other hand, consider the downside risk of an FI who misread the direction of interest rates

and erroneously positioned itself (i.e., through a positive gap of 6-month loans and 1-year

borrowings)

Borrowings 80,000 (10,400)

Equity 20,000 4,408 20.4%

UP CBA

- Partial Income Statement for Manufacturing CompanyЗагружено:Mary
- Notes Chapter 4 FARЗагружено:cpacfa
- 2012 FAR ContentЗагружено:study-for-career
- FAR Material Cross ReferenceЗагружено:alik711698
- 2012 Edition Becker - Financial Final ReviewЗагружено:jadeane1080
- financial analysisЗагружено:pearlcrystalraj
- Module 1 - Handout 5e[1]Загружено:pi_31415
- FAR 1 NotesЗагружено:DavEriKev
- accountingЗагружено:Jermey TooFly SCott
- Accounting and FinanceЗагружено:Luvnica Verma
- FAR 2 NotesЗагружено:DavEriKev
- financial statementЗагружено:Cecilia Cajipo
- FAR Study PlanЗагружено:burhankhan26
- Financial Accounting 123Загружено:shekhar87
- FAR430 (1)Загружено:Aisyah Azra
- FAR 4 ASSIGNMENTЗагружено:zarfarie aron
- FL087-Accounting Concepts and Principles Study ManualЗагружено:Bi Log
- MC Questions Ch 24-1Загружено:lynn_mach_1
- FAR250_260_FAC250_391Загружено:azri05
- OutlineЗагружено:hollan70
- 20070920180637531Загружено:kirkthejerk
- Exam 1 Material CombinedЗагружено:Erika Piggee
- Cluster 1(Financial Acctg)Загружено:Carl Angelo
- TheUniformCPAExaminationЗагружено:Vonn Punzalan
- Chap 05Загружено:eachirem
- RMIT Summary Note Study OrganiserЗагружено:lhydaniel
- Quick FASB Codification GuideЗагружено:goldbox
- accountingЗагружено:Sri Kanth
- financial reportingЗагружено:Chhagan Pithadia
- FAR SUmmaryЗагружено:nwasquad

- Portfolio AnalysisЗагружено:Shailesh Kediya
- FRM Assignment3Загружено:Anjali
- (2)Financial Institution & Market (Modified)Загружено:Aboi Boboi
- Uti and BirlaЗагружено:Reuben Jacob
- AquagrofundЗагружено:api-26119021
- Seacor Holdings Inc - Form 10-Q(Oct-28-2011)Загружено:allensm
- David Weinbaum Put-Call Parity and Stock ReturnsЗагружено:ljayoung
- Jim Rogers - Wikipedia, The Free EncyclopediaЗагружено:ballpaa
- Week 6_option_Futures.pdfЗагружено:winfld
- Sudha Deepthi Project WorkЗагружено:Mohammad Akram
- Types of ModelЗагружено:2460985
- IFSR Guide by Pwc.pdfЗагружено:Fazlihaq Durrani
- Sri Lanka Banking Sector Report- Pulling Through Macro Challenges - 09-May-2013Загружено:ishara-gamage-1523
- Serco Ratio AnalysisЗагружено:fcfroic
- A critical analysis of APT and CAPMЗагружено:anon_269423237
- Investment Options Avialable and Its Meaning in Brife.Загружено:Dipak Patil
- UntitledЗагружено:api-163183383
- ZAFPOOLEDЗагружено:Anonymous RT1MEWoN1e
- RHFL Investor Ppt Final v1 MumbaiЗагружено:PrasannaKamath
- Ec 1723 Pset 1Загружено:Fanny Sylvia C.
- ViewЗагружено:john183790
- Avid Cost of Venture Debt With Warrants and Net Interest Template.pptxЗагружено:Seema
- Innovatimmbe Perpetual Debt InstrumentЗагружено:Arunava Banerjee
- MBS South AfricaЗагружено:Quant_Geek
- Quiz1 AnswersЗагружено:Uraan Khan
- CFA Before the ExamЗагружено:pingu_513501
- Foreign Exchange ExposureЗагружено:jainkushal66
- Securities and Exchange Commission (SEC) - formta-2Загружено:highfinance
- What is Repo RateЗагружено:Ratnakar Aleti
- Hedge Funds RegulationЗагружено:Oleksandr Mazniker

## Гораздо больше, чем просто документы.

Откройте для себя все, что может предложить Scribd, включая книги и аудиокниги от крупных издательств.

Отменить можно в любой момент.