Quick question regarding the impact on bond yields from accelerated bond repayments. How are YTMs impacted upon a portion accelerated repayment of the principal from the sinking fund redemption? I would expect the ytm to go down as duration falls, but am wondering if anyone has better explanations?
Thanks
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I'm not sure what your asking... if you were refunding the sinking fund I would think your duration would increase because typically you would refund closer maturities first, which would more heavily wieght the longer term bonds. I don't think ytm would be affected unless you actually changed the coupon or the price of the bond. If a certain term isn't refunded then that investor would still be receiving the same ytm regardless of what you did with other investors. Someone correct me if I'm wrong, but this post sounds confused.
YTM would not change based on a partial early repayment of the principal.
Say you had a $100, 5%, 1 year bond. You paid $95 on it. The YTM is going to be (105/95)-1 = 10.5%
Now you're getting $100 no matter if it's paid today or at maturity 1 year from now, right? So, YTM won't change.
Duration would go down, sure. And duration and price are inversely related, if I remember correctly. So as duration decreases, price increases.
I think he's talking about annualized yield, not return on original principle. The YTM/YTW is not affected by early repayments only when it's trading at par. In reality, it's not always so simple.
The effect of a call is generally to increase the yield if the bond is trading below par or (almost always the case) decrease the yield to call if the bond is trading above par. In analytics land, we would typically assume that corporate CFOs aren't idiots and price via Yield-to-Worst- if the bond price would otherwise trade above the bond price, it gets called at the date that provides the greatest difference in prices.
The sinking fund affects the duration of the bond. So assuming the bond is issued at par, you buy it at par, and you hold until maturity, your interest rate is still the 5% it was issued at. But if it's a 10-year-bond straight line paydown starting five years before final maturity, that reduces your duration from something like 8 by maybe 2-2.5 to ~6. So if the bond price goes up to 110, that implies a much lower YTM for a sinking fund bond than for a non-sinking-fund bond- that extra 10 is getting spread over a much smaller duration to reduce yields rather than a longer one.
Stuff starts getting really annoying and weird when you start mixing optionality with sinking funds with fixed rate and floating rate provisions. Every bond is bespoke and they all have a lot of weird features. I strongly recommend going over the call schedule and sinking fund schedule in the prospectus very carefully. It's also been a while since I've priced bonds.
That's true, I was too simplistic in my response and that was my bad. Early repayment reduces duration, which causes the price to go up. So, if it does go up to $110 over $100 (if you bought at par), you're looking at a YTM of something like:
=RATE(5, 5,-110,100) = 2.83%
versus a non-sinking fund bond, priced the same, and held at 10 years:
=RATE(10,5,-110,100) = 3.78%
or
=RATE(10,5,-100,100) = 5%
The only way YTM does not change is if the bond price doesn't change. Again, my bad - I didn't think through my response fully.
Do you want to buy greek bonds ?
Thanks everyone. Yes I was thinking about the yield with respect to Duration and that seems to make sense. Any good recommendations on books for bond pricing? Never took one in b-school and now it's coming back to haunt me...
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