Question

QUESTION 3

1. Clearly explain the features of Fixed Income Securities. Illustrate your response with a relevant example from the Zambian financial markets.

                                                                                            [10 Marks]

2. A 364 Days Treasury bill of K1,000 Face Value is currently on offer at K840.33.

1. Calculate its Yield to maturity (YTM) at this price.

                                                                        [03 Marks]

2. Assuming the market yields for similar Bills were 200 basis points higher and lower, calculate the trading price of the bill under each case.

                                                                                 [03 Marks]

3. Briefly comment on the relationship between the price of the Bill and its YTM exhibited above.

                                                                                 [04 Marks]

Total 20 Marks

Answer 1

a]

Fixed income securities have the following features :

• Fixed income securities have a maturity date, when the principal is repaid
• Par value - they have a par value, or face value, which represents the principal borrowed
• They may be coupon securities, in which case they pay period coupon payments, or they may be zero-coupon securities, in which case they are issued at a discount to par value and there are no periodic coupon payments

For example, a Zambia Government bond maturing in April 2024 carries a coupon rate of 8.5% and a par value of $1,000.

International bonds: Zambia 8.5% 14apr2024 USD (XS1056386714, 988895AE8) Status Country of risk Maturity (option) Amount o outstanding Zambia **/**/**** 1,000,000,000 USD Registration required. Please log in or fill in the registration form. Excel WatchList Calculator Compare View events Issue Cash flow Covenants Credit ratings Files Buy a document Prospectus Issue information Borrower Zambia Placement date Bond type Maturity date Coupon bonds Open subscription Placement method Floating rate Placement type Public Coupon Rate Par amount, integral multiple 1,000 USD Current coupon rate

b]

i]

Price of bill = par value / (1 + YTM)^{years to maturity}

840.33 = 1000 / (1 + YTM)¹

YTM = (1000 / 840.33) - 1

YTM = 19.00%

ii]

If yields are 200 basis points higher

YTM = 19.00% + 2% = 21%

Price of bill = par value / (1 + YTM)^{years to maturity}

Price of bill = 1000 / (1 + 21%)¹

Price of bill = K826.45

If yields are 200 basis points lower

YTM = 19.00% - 2% = 17%

Price of bill = par value / (1 + YTM)^{years to maturity}

Price of bill = 1000 / (1 + 17%)¹

Price of bill = K854.70

iii]

As exhibited above, the YTM and bill price have an inverse relationship.

Higher the YTM, lower the bill price and lower the YTM, higher the bill price.