102 Session 10

Calculate par yield

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Jargon: What’s a par yield?

It’s a kind of average yield.

The par yield is p%,

where a bond paying a coupon of p% pa is priced at par
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What does “priced at par” mean? 100

Priced at par means the price is 1, or 100%. 0

Cost Pay
Or, put another way, -100 100 100
(+p)
the price per £100 nominal is £100.
-200

E.g. suppose the 5 year par-yield is 7%.

Then a 5 year bond paying a 7% annual coupon would be priced at

£100 per £100 nominal.

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Specimen Q3

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Specimen Q3

Rough guess:
par yield ≈
…. year spot yield ≈ average
forward rate =
1/3 * (6% + 6½% + 7%) = ….%
0 1 2 3

Par yield is p: bond paying p is priced at par 1 "grows to"

Ie …….. = pv(1) + pv(2) + (100+p)v(3)
=> 100 – …… v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant:
1.06 * 1.065
v(1) = 1/……. 1 1.06 1.06 * 1.065 * 1.07
v(2) = v(1) / 1.065
v(3) = v(2) / …….
⇒p = ……. per £100 nominal 312
⇒Par yield = ……..% (close to guess?)
Specimen Q3

Rough guess:
par yield ≈
3 year spot yield ≈ average
forward rate =
1/3 * (6% + 6½% + 7%) = 6½%
0 1 2 3

Par yield is p: bond paying p is priced at par 1 "grows to"

Ie 100 = pv(1) + pv(2) + (100+p)v(3)
=> 100 – 100 v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant:
1.06 * 1.065
v(1) = 1/1.06 1 1.06 1.06 * 1.065 * 1.07
V(2) = v(1) / 1.065
V(3) = v(2) / 1.07.
⇒p = 6.478 per £100 nominal 313
⇒Par yield = 6.478% (close to guess)
Specimen Q3

Model answer

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Apr 2001 Q8(ii)(b)

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Apr 2001 Q8(ii)(b)

Close guess:
par yield ≈
….. year spot yield =
0 1 2 0.04 + …/1000 = ……………%

Par yield is p: bond paying p is priced at par 1 "grows to"

Ie …….. = pv(1) + (100+p)v(2)
⇒100 – …… v(2) = p[ v(1) + v(2) ].
Interest rate isn’t constant:
v(1) = 1 / (1 + y….) 1.042^2
1.041
v(2) = 1 / (1+y2)….. 1
⇒…….–100 * 1.042-2 = p [ 1.041-1 + 1.042-2]
⇒p% = Par yield = …….% (close to guess?) 316
Apr 2001 Q8(ii)(b)

Close guess:
par yield ≈
2 year spot yield =
0 1 2 0.04 + 2/1000 = 0.042 = 4.2%

Par yield is p: bond paying p is priced at par 1 "grows to"

Ie 100 = pv(1) + (100+p)v(2)
⇒100 – 100 v(2) = p[ v(1) + v(2) ].
Interest rate isn’t constant:
v(1) = 1 / (1 + y1) 1.042^2
1.041
v(2) = 1 / (1+y2)2 1
⇒100–100 * 1.042-2 = p [ 1.041-1 + 1.042-2]
⇒p% = Par yield = 4.198% (close to guess) 317
Apr 2001 Q8(ii)(b)

Model answer

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Apr 2003 Q6(ii)

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Apr 2003 Q6(ii) growth factors

1 at time 0 "grows to" 1 at time 1 "grows to"

1 1.118 1.14
1

1 at time 1 "grows to" 1 at time 0 "grows to"

1.14 x
1.118 / 1.118 /
1 1.058 1 1.118
1.058 1.058
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 Apr 2003 Q6(ii)

Rough guess:
par yield ≈
3 year spot yield
= [………x 1.118 / 1.058 ) ]⅓ - 1
= ……..%
0 1 2 3
Par yield is p: bond paying p is priced at par
Ie …….. = pv(1) + pv(2) + (100+p)v(3) 1 at time 0 "grows to"
=> 100 – 100 v(3) = …..[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant: 1.14 x
v(1) = …….. / (1118 / 1.058) 1.118 / 1.118 /
1 1.118
v(2) = 1000 / …………. 1.058 1.058
v(3) = V(1) * ………. / 1140. 321
⇒Par yield = p% = 6.36% (near guess)
 Apr 2003 Q6(ii)

Rough guess:
par yield ≈
3 year spot yield
= [1.14 x (1.118 / 1.058 ) ]⅓ - 1
= 6.4%
0 1 2 3
Par yield is p: bond paying p is priced at par
Ie 100 = pv(1) + pv(2) + (100+p)v(3) 1 at time 0 "grows to"
=> 100 – 100 v(3) = p[ v(1) + v(2) + v(3) ].
Interest rate isn’t constant: 1.14 x
v(1) = 1000 / (1118 / 1.058) 1.118 / 1.118 /
1 1.118
v(2) = 1000 / 1118 1.058 1.058
v(3) = V(1) * 1000 / 1140. 322
⇒Par yield = p% = 6.36% (near guess)
Apr 2003 Q6(ii)

Model answer
(assumes you already have calculated the spot rates i1, i2, i3)

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 Key question
Understand April 2003 Q6(ii).

It doesn’t matter how many times you see the

answers.

You understand when you can make it seem

straightforward to someone else.

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Next session: forward prices

END
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