Synthesis: Fixed Income Analysis Framework

A framework for approaching fixed income questions on the exam, drawing together bond pricing, yield relationships, and risk factors.

Step 1: Determine Price Relationship

If You Know...	Then...
Yield to Maturity (YTM) > Coupon	Bond is at discount
YTM < Coupon	Bond is at premium
YTM = Coupon	Bond is at par
Current Yield (CY) > Coupon	Bond is at discount
CY < Coupon	Bond is at premium

Step 2: Apply the Appropriate Yield

Bond Trading At	Focus On
Discount	YTM (issuer will not call)
Premium	Yield to Call (YTC) (issuer likely to call)
Par	All yields are equal

Step 3: Assess Risk Profile

Risk Factor	Key Question
Duration	How sensitive is this bond to rate changes?
Credit rating	How likely is default?
Credit spread	How much extra yield for the credit risk?
Call features	Could reinvestment risk materialize?
Maturity	How long is the investor exposed?

Step 4: Consider Special Features

Feature	Key Consideration
Callable	Reinvestment risk; YTC most relevant for premium bonds; use effective duration
Puttable	Benefits bondholder when rates rise; lower coupon than comparable bonds
Convertible	Use par value for conversion ratio; trades at greater of bond value or conversion value
Zero-coupon	No reinvestment risk but highest volatility; phantom income tax; best for tax-deferred accounts

The Master Yield Ranking

\text{Discount: } \text{Nominal} < \text{CY} < \text{YTM} < \text{YTC}

\text{Premium: } \text{Nominal} > \text{CY} > \text{YTM} > \text{YTC}

\text{Par: Nominal = CY = YTM}

Key Formulas

\text{Current Yield} = \frac{\text{Annual Interest}}{\text{Market Price}}

\text{Taxable Equivalent Yield (TEY)} = \frac{\text{Tax-exempt Yield}}{1 - \text{Marginal Tax Rate}}

\text{Conversion Ratio} = \frac{\text{Par Value}}{\text{Conversion Price}}

\text{Conversion Value} = \text{Conversion Ratio} \times \text{Stock Price}

\text{Credit Spread} = \text{Corporate Bond Yield} - \text{Treasury Yield}

\text{Price Change} \approx -\text{Duration} \times \text{Change in Yield}

Exam Tip: Gotchas

Yield to Worst (YTW) is always the LOWEST possible yield - the most conservative measure. It is the lesser of YTM, YTC, or any yield to a put date.

Discounted Cash Flow (DCF) value > market price means undervalued (buy). DCF value < market price means overvalued (sell).