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2. Content. Thai Bond MarketReturn vs RiskRisk MeasurementPortfolio Management
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1. 1 Advanced Fixed-Income Trading 26 November 2005
by
Sansanee Hutanuwatr
2. 2 Content Thai Bond Market
Return vs Risk
Risk Measurement
Portfolio Management & Strategy
Active Trading Strategies
3. 3 Thai Bond Market
4. 4 Outstanding as of 31 Oct 05 #Issues Value (Billion Baht)
Government Debt Securities : 505 2,559
- Treasury Bill 39 170
- Government Bond 34 1,264
- State Agency Bond 62 644
- State Owned Enterprise Bond 370 481
Corporate Bond 194 422
Foreign Bond 2 7
Total Registered Bonds 701 2,988 Registered Bonds in TBMA
5. 5 Registered Bonds by Value
6. 6 Trading Volume
7. 7 Classified by #Issues Value (Billion THB) %
Bond Type
Straight 132 296 70
Convertible 1 2 1
Amortised 54 115 27
Structured 7 8 2
Issue Rating
A-rated 132 343 81
B-rated 46 62 15
Non-rated 16 17 4
Coupon Type
Fixed 166 364 86
Float 28 58 14 Corporate Bonds in Focus
8. 8 Government / SOE / Corporate Bond
LB 08 D A
Version of bond (1st Issue)
Maturity month (December)
Next 2 : Maturity year (2008)
First 4 characters: Short name of bond (Loan Bond)
T-Bill, CB
TB 05 N 23 B Bond Symbol
9. 9 Return vs Risk
10. 10
11. 11
12. 12 Current Spread
13. 13 Return Return from fixed-income investment:
Coupon
Coupon Reinvestment
Capital Gain (Loss)
Assumptions of Yield-to-Maturity (YTM)
Reinvestment rate = YTM
Hold-to-Maturity
14. 14 Horizon Return Step 1: Make assumptions on
- Time horizon
- Reinvestment rate
- Bond yield at end of horizon
Step 2: Calculate future value of cash flows ?
Step 3: Calculate bond price at end of horizon ?
Step 4: ? = ? + ?
Step 5: Period Return ?
Step 6: Convert to bond equivalent yield = (1+ ?)k - 1
15. 15 Horizon Return 7 Yrs bond, coupon 9%, current price = 100, YTM = 9%
Step 1: Assuming
- Time horizon = 1 yr
- Reinvestment rate = 5%
- Bond yield at end of horizon = 7%
Step 2: Future value of cash flows = 4.5x(1.025)2 + 4.5x(1.025) = 9.3403
Step 3: Bond price at end of horizon = 109.6683
Step 4: 9.3403 + 109.6683 = 119.0036
Step 5: Period Return = (119.0036 / 100) ˝ - 1 = 9.09%
Step 6: Bond equivalent yield = (1.0909)2 – 1 =19.01%
16. 16 Horizon Return Horizon Return > YTM when
- Reinvestment rate > YTM
- Bond price at end of horizon > Par
(Selling YTM < Invested YTM)
Coupon reinvestment income has greater effect for long time horizon
Capital gain has greater effect for short time horizon
17. 17 TBDC Index TBMA Government Bond Index
(Total Return Index, Clean Price Index, Gross Price Index)
Sub group 1 : 1 < TTM < = 3 Years
Sub group 2 : 3 < TTM < = 7 Years
Sub group 3 : 7 < TTM < = 10 Years
Sub group 4 : TTM > 10 Years
TBMA Corporate Bond Index
(Total Return Index, Clean Price Index, Gross Price Index)
18. 18 Yield Curve Movement : 4 Jan – 31 Oct 05
19. 19
20. 20 Risks in Fixed Income Investment Market / Interest Rate Risk
Reinvestment Risk
Credit / Default Risk
Marketability / Liquidity Risk
Inflation / Purchasing Power Risk
Call Risk
Exchange Rate / Currency Risk
Event Risk
Political / Legal Risk
Black-Box Risk
21. 21 Risk Measurement
22. 22 Price-Yield Relationship
23. 23 Price Volatility Measurement %Price Change ~
24. 24 Duration Macaulay Duration: Weighted average of times until each payment is made
25. 25 Modified Duration Price Volatility & Measurement
26. 26 Factors Affecting Duration (All other things held constant)
Maturity : Long =>
Coupon : High Coupon =>
Zero coupon
Floating rate
Amortising : More principle prepayment =>
YTM : High YTM =>
27. 27 Rearrange from highest to lowest duration
28. 28 Convexity
Measure how convex the curve is (2nd Dif)
Convexity: - Prices rise at increasing rate as yield fall
- Price decline at decreasing rate as yield rise.
Positive attribute of bond
The more money exposed to bigger exponents, the greater the convexity Price Volatility & Measurement
29. 29 Price Volatility Measurement Example : We invest THB 10,825,000 in LB08DA @ YTM 5.5% Modified Duration = 2.6
Convexity = 8.7
Question: How would our investment value change
if YTM of LB08DA increases 10 bps to 5.6%?
30. 30 Price Volatility Measurement
31. 31 Price Volatility Measurement
32. 32 Credit Risk Measurement Credit Scoring Model
In-House Model
Market Model
Altman Z-Score
Springate Model
Logit Model
33. 33 Altman Z-Score Z = 1.2X1+ 1.4X2+ 3.3X3+ 0.6X4+ 1.0X5
Where X1 = Working capital / Total assets
X2 = Retained earnings / Total assets
X3 = EBIT / Total assets
X4 = MV of equity / BV of long term debt
X5 = Sales / Total assets
Higher Z, lower default risk
Use by credit officer when judge corporate borrowers
Ex. If Z < 1.81, reject the loan
34. 34 Springate Model Z = 1.03A + 3.07B + 0.66C + 0.4D
Where A = Working capital / Total assets
B = Net profit before interest and tax / Total assets
C = Net profit before tax / Current liabilities
D = Sales / Total assets
If Z < 0.862, Fail
35. 35 Logit Model Y = 0.23883
- 0.108 x Investment / Sales
- 1.583 x Receivable / Investment
- 10.78 x (Cash+ Marketable security) / Total asset
+ 3.074 x Quick asset / Current Liability
+ 0.486 x Operating income / (Total asset - Current liabilities)
- 4.35 x Long term debt / (Total asset-Current liability)
+ 0.11 x Sales / (Net working capital + Fixed asset)
Probability of bankruptcy = 1/(1+eY)
36. 36 Portfolio Management & Strategy
37. 37 Portfolio Management Setting Objectives
Establishing Investment Policy
Time horizon, Risk tolerance, Liquidity needs, Regulatory constraints, Tax
Selecting Portfolio Strategy
Selecting Individual Bond
Maturity, Credit quality, Embedded option, Convexity
Measuring & Evaluating Performance
38. 38 Core Portfolio Setup Forecast yield curve movement
Calculate Horizon Return of each bond
Optimization
SHARPE = (Expected Return-Rf)/sp
39. 39 Portfolio Structuring
40. 40 Anticipation
1. Changing Interest Rate Level
2. Changing Yield Curve Shape
3. Changing Spread
- Between bond sector
- Between individual bond
4. None Active Portfolio Management
41. 41
Expect interest rate Duration
Expect interest rate Duration Changing Interest Rate Level
42. 42 Factors Affecting Yield Curve Interest Rate
Inflation
Economic Growth
Demand
Supply
43. 43 Factors Affecting Yield Curve
44. 44 Factors Affecting Yield Curve
45. 45 Factors Affecting Yield Curve
46. 46 Parallel Shifts (Upward / Downward) Changing Yield Curve Shape
47. 47 Twists (Flattening / Steepening) Changing Yield Curve Shape
48. 48 Humps (Butterfly Shifts) Changing Yield Curve Shape
49. 49 Yield Curve Strategy
50. 50 Yield Curve Strategy
51. 51 Yield Curve Strategy
52. 52
Negative Butterfly: Sell Body, Buy Wings
Positive Butterfly: Sell Wings, Buy Body Yield Curve Strategy
53. 53 Trading Strategies
54. 54 Intermarket Spread Swap Strategy Between Bond Sectorswap)
Quality Spread
- Widen as economy deteriorate (Flight to Quality)
- Narrow as economy improve (Flight from Quality)
- Buy improved industry, sell deteriorate industry
Callable vs Non-callable Bond Spread
- Widen in high interest rate volatility
- Narrow in low interest rate volatility
Between Individual Bond
Temporary divergence: Buy cheaper one
Credit : Buy better perform one
55. 55 Bond Swap If no anticipation…
Pure yield pickup swap
Buy bond with higher YTM, given same duration
Buy bond with lower duration, given same YTM
Bullet - Barbell
Substitution swap
Buy bond with higher YTM, given identical features (Due to market imperfection, temporary imbalance)
56. 56 Bond & IRS We can use IRS (Interest Rate Swap) with fixed-income portfolio
- to hedge or
- to enhance return
57. 57 IRS Transaction
58. 58 For Hedging If expect yield to increase
Enter pay fix, receive float
Duration of portfolio will reduce
59. 59 IRS for Hedging
60. 60 Pair Trade using IRS Monitoring IRS spread. If spread reduces significantly
You believe government bond is cheap, swap is rich
Enter pay fixed, receive float
Unwind when spread turn back to normal
Effectively you long government bond and short fixed rate swap
61. 61 For Yield Enhancement If expect yield to drop
Enter pay float, receive fixed
You effectively increase portfolio duration