NISM Series XV : Research Analyst Certification Exam Notes
Page 27 Of 62
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If an investor purchases a bond at Rs. 104, earns Rs. 8 as coupon, which he reinvests at 7% for a period of 1 year, and finally sells the bond at Rs. 110 after 1 year then his HPR would be: HPR = [(8) + (8 * 7%) + (110-104)]/ 104 = 14.00% - It must be noted that HPR is single period return and does not annualize the return to the investors.
Current Yield - coupon is divided with the current market price of the bond and the result is expressed as percentage. This method does not take into account future cash flows coming from the bond, which is the biggest drawback of this method and hence this method is not really used widely
Yield to Maturity (YTM) is a more comprehensive and widely used measure of return calculation of a debt security than current yield. This method takes into consideration all future cash flows coming from the bond (coupons plus the principal repayment) and equates the present values of these cash flows to the prevailing market price of the bond. The rate which equates the present outflow (price of the bond which the investor needs to pay in order to purchase the bond) with the present value of future inflows (coupons plus principal) is known as YTM. Thus, it can be understood as the Internal Rate of Return (IRR) of the bond.
Duration - Duration measures the sensitivity of the price of a bond to changes in interest rates. Bonds with high duration experience greater increases in value when interest rates decline and greater losses in value when rates increase, compared to bonds with lower duration.
Duration is the weighted average maturity of the bond, where the present values of the future cash flows are used as weights. Duration thus incorporates the tenor, coupon and yield in its calculation.
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