Fair Valuation of Rarely Traded Bonds Utilizing the Coupon Effect on YTM
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Yield‐to‐maturity (YTM) is a widely accepted concept in practice. The YTM is related not only to such market‐wide factors as the term structure of spot rates but also to such specific factors of individual bonds as coupon rate, maturity and credit risk. This study isolates the effect of coupon rate on YTM when bonds are identical in all respects except for coupon rates. Two approximation measures of YTM according to varying coupon rates are derived. Numerical examples give an evidence of the validity of the results. If the coupon effect derived in this study is used for matrix pricing in mutual fund industry or bond trading together with the concepts of duration and convexity, more precise bond prices could be obtained.
Abstract
Yield‐to‐maturity (YTM) is a widely accepted concept in practice. The YTM is related not only to such market‐wide factors as the term structure of spot rates but also to such specific factors of individual bonds as coupon rate, maturity and credit risk. This study isolates the effect of coupon rate on YTM when bonds are identical in all respects except for coupon rates. Two approximation measures of YTM according to varying coupon rates are derived. Numerical examples give an evidence of the validity of the results. If the coupon effect derived in this study is used for matrix pricing in mutual fund industry or bond trading together with the concepts of duration and convexity, more precise bond prices could be obtained.