Question

in 2-3 paragraphs please discuss, please dont be heavy in financial/investment jargon, keep the explaination simple.

Describe the various measures of yield and return and explain how these standards of performance are used in bond valuation; understand the basic concept of duration, how it can be measured, and its use in the management of bond portfolios.

Answer 1

Current yield is the annual interest on the bond market price. It uses coupon interest in numerator and bond price in denominator. Given the current yield and coupon interest, one can find the bond market price. Higher the discount on bond, higher the current yield.

Yield to maturity (YTM) is the rate of return on the bond that makes the PV of the future cash flows equal to the price of bond today. Given the coupon, maturity and face value of bond, YTM can be used to find the price of the bond

Yield to Call/Put is like the yield to maturity, except for the fact that face/par value is replaced by call/put price.

Total return is the total return on bond which includes all coupons & interest incomes.

Duration is measure of risk of the bond. It calculates as to when all the cash flows of the bond will be received. The higher cash flows later in the term of bond, higher will be the interest rate risk. It is measured in no of years. It can be measured by the PV of cash flows of bond weighted by the length of time to receipt divided by market price of bond

In management of bond portfolios, it is used as an immunisation measure against interest rate risk.It is adjusted in such a way that it matches the investor time horizon so that there is no mismatch of liabilities. Also based on interest rate forecasts, managers alter the durationof portfolio to mitigate or benefit from interest rate changes. If interest rates are going to fall, bond prices will rise. Higher the duration, higher the rise in price.