Components of yield

Bond Valuation and Analysis in R

Clifford Ang

Senior Vice President, Compass Lexecon

Baseline component of yield

  • Risk-free yield (baseline rate)
    • Yield on recently issued US Treasury with similar maturity
  • Risk-free yield is not constant
    • Affected by economy, market interest rates, and inflation
Bond Valuation and Analysis in R

Obtaining treasury data

  • Use quantmod package
  • Obtain 10-Year Treasuries ("DGS10") from FRED
library(quantmod)
t10yr <- getSymbols("DGS10", src = "FRED", auto.assign = FALSE)
head(t10yr)

           DGS10
1962-01-02  4.06
1962-01-03  4.03
1962-01-04  3.99
1962-01-05  4.02
...
Bond Valuation and Analysis in R

Spread component of yield

  • Spread
    • Primarily the credit spread = risk that issuer will default
    • May contain premiums for other risks
Bond Valuation and Analysis in R

Risks of investing in bonds

  • Credit Risk: Risk of default by issuer
  • Inflation Risk: Risk that inflation eats up value of cash flows received from bond
  • Call Risk: Risk that issuer will buyback the bond at a time that is disadvantageous to the investor
  • Liquidity Risk: Risk that you cannot sell the bond for a price that is at or near its value
Bond Valuation and Analysis in R

Time-varying risk premiums

  • Depends on market's current appetite for risk
    • Nervous markets → larger risk premium
  • One measure is Investment Grade spread (i.e., difference in Baa and Aaa yields)
  • Obtain Moody's Aaa and Baa Index yields from the quantmod package
Bond Valuation and Analysis in R

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Bond Valuation and Analysis in R

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