Fixed Income and Money Market Instruments
Fixed Income and Money Market Instruments tests pricing, yield, duration, credit, and short-term instruments. The exam expects you to know why bond prices move opposite to yields and how to distinguish coupon, current yield, and yield to maturity (YTM).
Core rules
- Bond price is the present value of coupons and principal at the required yield; premium when coupon > YTM, discount when coupon < YTM.
- YTM assumes coupons reinvested at YTM and held to maturity; it is not the same as the coupon rate.
- Duration measures price sensitivity to yield; longer maturity and lower coupon generally mean higher duration.
- Credit spread compensates for default and liquidity risk; a rating downgrade widens spread and lowers price.
- Money market instruments include T-bills, commercial paper, NCDs, and repos; they are short-term and often quoted on a discount or add-on basis.
- Clean price excludes accrued interest; dirty price includes it.
Worked example
A 2-year bond pays a 6% annual coupon on a PHP 100 face value and yields 8%. Price = 6/1.08 + 106/(1.08)^2 = 5.56 + 90.88 = PHP 96.44. It trades at a discount because the 6% coupon is below the 8% required yield. If the yield falls to 7%, the price rises; the direction is certain even without recalculating.
Traps
Do not quote the coupon as the return. Do not assume a high coupon means low risk. Do not ignore accrued interest in settlement. Do not confuse duration with maturity. For T-bills, do not mix discount yield with add-on yield.