Easy version - Accounting bond yield changes

jc2018jc2018
in CIA.Accting

Hi Graham,

I think in the calculation template, it should say APV(claim liab + PfADs @ yield rate) and APV(claim liab + PfADs @ new yield) instead of APV(@investment rate) and APV(@investment rate-MfAD).
In my opinion, the difference in the two latter would give MfAD(inv) which is not what we are looking for.

Regards,

Comments

  • grahamgraham

    I think the issue here is my notation. I have changed it to make it clearer.

    When I wrote APV(@investment rate), I meant the normal APV of claim liabilities calculated at the original yield. And when I wrote APV(@investment rate - MfAD), I meant the normal APV of claim liabilities calculated at the NEW yield. But it isn't obvious that these are the same. I have changed the practice template to be clearer. If you want a fuller explanation, please see below.

    There is a really big TRICK in this problem but you only see it if you look at the hard version. There are 2 example PDFs in the hard version in the wiki. The TRICK is that the change in bond yield equals MfAD(inv). It this wasn't true, you would have to calculate PV for 4 different discount rates to get the APV of the claim liabilities at the original yield and the NEW yield:

    • PV using (original yield)
    • PV using (original yield minus MfAD(inv))
    • PV using (NEW yield)
    • PV using (NEW yield rate minus MfAD(inv))

    But if it is the case that change in bond yield equals MfAD(inv), (assuming the NEW rate is higher) then the first and fourth rates above are the same. For example, if the given rate is 5.5%, MfAD(inv) = 100bps, and the NEW rate is 6.5%. Then you only have to do the PV calculation 3 times instead of 4 times. And that's what was in my mind when I created the notation for the practice template. But like I said, I've now changed it to make it clearer.

    I hope I interpreted your question correctly. Please let me know if I haven't.

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