Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures, and Valuation, Second Edition

CHAPTER 5

Yield Measures

Abond’s yield is a measure of its potential return. Market participants commonly assess a security’s relative value by calculating a yield or some yield spread. There are a number of yield measures that are quoted in the market. These measures are based on certain assumptions necessary to carry out the calculation. However, they also limit effectiveness of a yield measure in gauging relative value. In this chapter, we explain the various yield and yield spread measures as well as document their limitations.

SOURCES OF RETURN

The source of dollar return an investor expects to receive comes from three potential sources:

1. The periodic interest payments made by the issuer (i.e., coupon payments).

2. Any price appreciation/depreciation, when the bond matures, is sold by the investor, or is called by the issuer.

3. Income earned from reinvestment of the bond’s interim cash flows (i.e., coupon payments and principal repayments).

In order to be a useful indicator of a bond’s potential return, a yield measure should account for all three of these potential sources of dollar return in a reasonable way. We begin our discussion by examining the three return sources in more detail.

We illustrate the three sources of dollar returns using the on-the-run 5-year Treasury note trading at 102-12 for settlement on November 20, 2007 (i.e., $102.375 per $100 of par value). The Bloomberg security description screen (DES) for this note is presented in Exhibit 5.1. This note ...