Financial Economics

金融经济学

1
Chapter 9: Principles of Risk
Management

Objective

Risk and Financial Decision Making

Conceptual Framework for Risk
Management
Efficient Allocation of Risk-Bearing
 Contents

9.1 What is Risk?

9.2 The Risk Management Process
9.3 Institutions for Risk Management
9.4 Portfolio Theory: Quantitative Analysis
for Optimal Risk Management
9.5 Probability Distributions of Returns
9.6 Standard Deviation as a Measure of Risk
 Introduction

• In this chapter, we examine the

valuation of fixed-income
securities and other contracts
promising a stream of known
future cash payments.
– Such as bonds, mortgages and
pension annuities.
 Introduction

• Having a method to value such

contracts is important for at least
two reasons.
- First, the parties to the contracts
need to have an agreed-upon
valuation procedure in setting the
terms.
- Second, fixed-income securities
are often sold before they mature.
 Structure

• 7.1—— presents a basic valuation

model
• 7.2—— show how to modify such a
model
• 7.3-7.5 —— explain the main
features of bonds, discuss how
these features affect the price and
yields of bond
7.1 Using Present Value Factors
to Value Known Flows

• For example, suppose you buy a

fixed-income security that promises
to pay $100 each year for the next
3years.
• How much is this three-year annuity
worth if you know that the discount
rate is 6% per year?
 Calculation
Using the present value of an
annuity formula discussed in
chapter 3, you will pay no more
than

pmt  n
 1  
PV  1  
i   1 i  

100   1  
3

 1   
0.06   1.06  
$267.30
 Calculation

• If the discount rate rises from 6% to 7%

per year, and you want sell, how much
can you get for it?

• The answer is 262.43

Using Present Value Factors to
Value Known Flows

• Observe that the price you would

pay for the security has decreased
• An increase in the discount rate of
return always leads to a decrease
in the value of a fixed income
security
• The proof is very easy
 Bond Prices Rise as the
Interest Rates Fall

• Write the PV of the fixed income

security as the sum terms
n  1 
j

PV   pmt j *   

j 1   1  i  
1 2 n 1 n
 1   1   1   1 
 pmt1 *    pmt2 *    ...  pmtn  1 *    pmtn *  
 1 i   1 i   1 i   1 i 
 Bond Prices Rise as the
Interest Rates Fall

• If i goes up, 1+i goes up, 1/(1+i) goes

down for i > -1, (1/(1+i))j goes down
for i > 0. So if the payments are
positive, then the sum must also go
down
• Similarly, i down, PV(price) up
 Bond Prices Rise as the
Interest Rates Fall

• The level of market interest rates

has changed, but the promised
future cash flows from your security
have not. In order for an investor to
earn 7% per year on your security,
its price has to drop.
 Bond Prices Rise as the
Interest Rates Fall

• Basic principle in evaluating known

flows
– A change in market interest
rates causes a change in the
opposite direction in the
market values of all existing
contracts promising fixed
payments in the future
 Finding the Correct
Discount Rate

• Bond analysis is not as easy as

this analysis appears to imply
– We need an interest rate to
use in the formula
– We saw in Chapter 2 that
interest rates are a function(
函数 ) of time-to-maturity
 Yield Curve
• A typical yield curve:
7.2 The Basics Building Blocks:
Pure Discount Bonds

• The promised cash payment on a

pure discount bond is called its face
value or par value. ( 票面价值 )
• A pure discount bond( 纯粹折现债券 ) is a
security that promises to pay a single
cash payment (face value or par
value)at a specified date called its
maturity date
• Zero-coupon bonds （零息债券）
 Pure Discount Bonds

• Note
– There is no cash flow
associated with interest
– Pure discount bonds are
purchased at a discount from
their face or par value
 Pure Discount Bonds

• The pure discount bond is an example

of the present value of a lump sum
equation we analyzed in Chapter 3
• Solving this, the yield-to-maturity on a
pure discount bond is given by the
relationship:
1
F n
F P 1  i 
n
 i    1
 P
 Pure Discount Bonds
1
Fn
F P 1  i 
n
 i    1
 P
• In this equation,
– P is the present value or price
of the bond
– F is the face or future value
– n is the investment period
– i is the yield-to-maturity
 Pure Discount Bonds

• Example
– You can purchase a pure
discount bond for $950, and it
matures in one year with a
face value of $1,000
– What is the yield-to-maturity?

5.26%
 Pure Discount Bonds

• Example
– You can purchase a pure
discount bond for $880, and it
matures in two years with a
face value of $1,000
– What is the yield-to-maturity?

6.60%
 Pure Discount Bonds

• Example
– You can purchase a pure
discount bond for $800, and it
matures in three years with a
face value of $1,000
– What is the yield-to-maturity?

7.72%
• For example, suppose you buy a
fixed-income security that promises
to pay $100 each year for the next
3years. How much is this three-year
annuity worth if you know that the
discount rate is 6% per year?
 习 题
• 某种零息债券还有 10 年到期，面值为 100 元，目前报价是
61.39133 元。如果想要保持该债券的收益率在接下来的 3 年内保持
不变，即在还有 9 年、 8 年、 7 年的剩余到期年限的这种债券需要按照什
么价格出售？
• 为了使拥有 6 年剩余期限的该债券的价格与两年前，也就是与拥有 8 年剩余
期限时的价格相同，收益率不得不上升多少？
• 这道题首先是要计算该债券在现在的情况下的收益率是多少，即
(100/61.39133)^(1/10)-1=5% 。
那么按现在的收益率 5% 情况下，即么剩余到期年限所对应的价格分别是：
9 年所对应的价格 =100/(1+5%)^9=64.46089 元
8 年所对应的价格 =100/(1+5%)^8=67.68394 元
7 年所对应的价格 =100/(1+5%)^7=71.06813 元
按照 8 年所对应的价格计算剩余到期年限为 6 年的收益率
=(100/67.68394)^(1/6)-1=6.72%
也就是说收益率不得不上升 1.72%(=6.72-5%) 。
 Pure Discount Bonds

– The fundamental building block

of bonds is the pure discount
bond: Coupon bonds may be
viewed as a portfolio of
discount bonds
– The rule of one price applies to
bonds through pure discount
bonds
 7.3 Coupon Bonds, Current
Yield, and Yield to Maturity
• A coupon bond obligates the issuer to
– make periodic payments of interest
(called coupon payments 息票支付 ) to
the bond holder until the bond
matures
– at which time the face value of the
bond is also paid to the bond holder
– Two features,
Coupon payment is fixed when issued
Remains constant until maturity date
 Coupon Rate( 票面利率 )

• The periodic payments of interest are

call coupons. （息票价值）
• The coupon rate is the interest rate
applied to the face value to compute
the coupon payment
• example
– A bond with a face value of $1,000
and a coupon rate of 10% pays an
annual coupon of $100
– At maturity, the payment is
$1,000+$100
Cash Flows for 10% $1,000
Coupon Bond
Par, premium, and Discount
Bonds

• Par Bonds 平价债券

• Premium Bonds 溢价债券

• Discount Bonds 贴现（折扣）债券

Par, premium, and Discount Bonds

• A coupon bond with its current price

equal to its par value is a par bond

• If it is trading below par it is a

discount bond

• If it is trading above par it is a

premium bond
Par, premium, and Discount
Bonds

• Bond Pricing Principle 1: (Par Bonds)

– If a bond’s price equals its

face value, then its yield-to-
maturity = current yield =
coupon rate.
Coupon Bonds, Current Yield,
and Yield-to-Maturity

• Current Yield
– The annual coupon divided by the
bond’s price
Current Yield = Coupon / Price
 Coupon Bonds, Current Yield,
and Yield-to-Maturity

• The yield-to-maturity is the discount rate

that makes the present value of the cash
flows from the bond equal to the current
price of the bond
n=<1, Ytm =(coupon + face value -
price)/price
n>1, 书 P175
Bond Pricing Principle #2 & 3

• Bond Principle # 2: Premium Bonds

bond price > face value  ytm <
current yield < coupon rate
• Bond Principle # 3: Discount Bonds
bond price < face value  ytm >
current yield > coupon rate
How to Remember Principles

• Imagine that the bond was issued

at par
– the yield-to-maturity moves from
the coupon yield in the opposite
direction to price
– the coupon rate is unchanging
• This diagram may help:
 Yield Relationships

0.2
0.18
0.16 coupon_y
0.14 current_y
y_t_m
0.12
Yield

0.1
0.08
0.06
0.04
0.02
0
600.00 800.00 1000.00 1200.00 1400.00 1600.00 1800.00
Price
Using Pure Discount Bonds
to Value other Bonds

• Value a bond that pays its $100 coupon

at the end of each year for 3-years, and
its par value of $1,000 in 3-years
• You have discovered three pure discount
bonds (each with a $1,000 par value)
that mature in 1, 2, and 3 years, and
that are trading at $960, $890, and $810
respectively
 First Solution Method

960 890 810

P 100  100  1000  100
1000 1000 1000
P $1076.00
Second Solution Method
1
 1,000 
1
i0 ,1    1 4.17%
 960 
1
 1,000  2
i0 , 2    1 6.00%
 890 
1
 1,000  3
i0 , 3    1 7.28%
 810 
100 100 1000  100
P  2

1.0417 1.0600 1.07283
P $1,075.91
 Conclusion

• The first method uses the fact that a

coupon bond is the sum of pure
discount bonds
– it is fast and direct
• The second method first determines
the yields-to-maturity of each
discount bond
– cash flows are then evaluated
using them
 7.5 Why Yields for the
same
7.5 Maturity
Why Differ
Yields for the
same Maturity Differ

• The effect of the coupon rate

• The effect of default risk and taxes
• Other effects on bond yields
– Callability （可赎回性）
– Convertibility （可转换性）