January 04, 2013Daily Rates & Viewpoints From the Officers & Staff of TIB.

Bond Pricing

In today’s challenging interest rate environment, we’re dealing with an unprecedented number of variables in our investment portfolios. It’s tough enough to deal with declining margins as we enter our sixth year of depressed rates, but now we have so many variables – and many of them seem to be more political than economic. As we continue our path of disciplined investing, I thought this would be a good time to go over the core building block for being a disciplined investor, which is understanding the basics of pricing and yield, and its application.

The core building block for understanding price and yield is simple:
The difference between the yield and the coupon, divided by the number of years remaining in the life of the bond will equal the premium or discount of a bond. While this might seem like a simple concept, its applications are immense.
For simplicity’s sake, let’s look at the current two-year treasury, which currently yields 0.25%. If you are offered a two year treasury with a coupon of 0.125%, what is the dollar price of the bond? With the information provided, you should be able to answer that question.
The coupon is 0.125% and the yield is 0.25%, so you know the bond is offered at a discount. Since the coupon is 0.125% less than the yield, you take the difference and multiply it by the number of years remaining – two years – and you get a discount of 0.25%. The dollar price of the bond will be 99.75.
So why is this knowledge useful? 
1)      The role it plays in agency callables
Think about a 5 year maturity agency callable with a 2 year 1X call at 1.30%. Two years from now, the agency will have to make a decision – leave the bond with you or call it. If they leave it with you, it’s a three year bullet. The agency will make the decision by asking itself where they issue a three year bullet. Currently, the three year bullet is roughly 0.40%. The one thing that you know is that if the three year part of the curve doesn’t rise more than 90 bps, your bond will be called. But let’s say rates rise 150 bps. You’ll be 20 bps underwater for three years – and the bond’s dollar price will be 99.40.
2)      The role it plays in affecting the gains/losses of your portfolio
Let’s say you bought a 10 year treasury at 1.70% on December 31. Currently, the 10 year Treasury is 1.84% after all the goings-on in Washington on New Year’s Day. The bond you own is 14 bps underwater for 10 years – the current dollar price on the bond is 1.4 points less than where you bought it on Monday. So if you bought the 10 year 1.75% coupon Treasury on Monday at a 1.70% yield, you likely paid a dollar price of 100.50. (5 bps premium for 10 years).   But currently, that coupon is 9 bps below the current yield of 1.84%. Current dollar price is 99.10 (9 bps discount X 10 years). 
3)      The role it plays in your ability to manage the your portfolio across the yield curve
With a positively sloped yield curve, as a bond ages, it “rolls down the curve”, and the yield spreads to a lower point on the yield curve. This is how most gains are built in a bullet/treasury/municipal portfolio. Utilizing the pricing and yield mechanics, a bank can work its portfolio along a steeper part of the yield curve and build gains more quickly.
If you’d like to discuss this or anything else, your TIB Capital Markets officer is standing by. We look forward to hearing from you!

Blake Scharlach Blake Scharlach
Vice President/TIB Capital Markets

Market Levels @ 7:26 AM CST

TIB Fed Funds & MMDA Rates - Previous Day
Agent 0.20% Prin 0.05% MMDA 0.30%
STAR Prin 0.10% STAR MMDA 0.35%
Key Indices/Commodities
1 - Month LIBOR 0.20% Dow Jones 13391.36
3 - Month LIBOR 0.30% NASDAQ 100 3100.56
1-Yr LIBOR 0.83% S&P 500 1453.30
1-Yr CMT 0.15% Spot Gold 1635.10
Prime 3.25% Spot Silver 29.52
3-yr LIBOR Swap/Offer 0.54% Spot Crude Oil 91.99
5-yr LIBOR Swap/Offer 0.96% CRB Index 295.65
3 Mo - Fed Fund Futures 99.87% 6 Mo - Fed Fund Futures 99.86%
US Treasury Yields US Non-Callable Agency Yields
Yield Maturity Yield Spread
0.00% 90 - Days    
0.02% 180 - Days    
0.23% 2 - Year 0.31% 8bp
0.37% 3 - Year 0.41% 4bp
0.81% 5 - Year 0.93% 12bp
1.92% 10 - Year 1.87% 5bp
3.13% 30 - Year    
169 BPs Yield Curve(2's-10's)
Sample 1x Callable Agency Issues
Description Call Date YTC YTM
FHLMC 1 07/25/18 1/16 1.00% 1.00%
Select MBS Levels
Description Coupon Yield Spread/Duration*
15-Yr FNMA 3.00% 1.37% 79 / 3.54
30-Yr GNMA 3.50% 2.28% 81 / 6.50
*Duration @ 12 month Historical CPR
Morning Commentary: Reed Bateman

Yesterday’s release of the most recent Fed minutes led Treasury prices lower, sending yields up through support levels.  Long term support of 1.89% on the 10-year becomes a near term resistance level, and the new long term range could be as wide as 1.40-2.40% until we see otherwise.  The selloff began after the meeting’s minutes cast uncertainty on the future of QE through 2013.  They reflected concern by a good portion of the FOMC committee members regarding the continued effectiveness of the program versus the future cost of adding to the Fed’s balance sheet.  Rates will still remain extremely low until the unemployment rate reaches 6.5%, or inflation becomes an issue.  We’ve seen Treasury prices stabilize a bit after this morning’s nonfarm payroll and unemployment figures were released.  Yesterday’s ADP number had market participants thinking this morning’s figures would be better than expected, but they were pretty much on top of forecasts.  Nonfarm payrolls rose by 155K for December, while private and manufacturing payrolls increased 168K and 25K respectively.  The unemployment rate came in at 7.8%, which meant it remained steady after being revised higher by 0.1% for the prior month.  The 10-year sits at 1.93% and equity markets are slightly lower just after the bell. 

Information contained herein is based on sources we believe to be reliable but its accuracy is not guaranteed. Customers should rely on their own outside counsel or accounting firm for specific circumstances. The securities, yields or levels discussed herein are for illustration purposes and are not guaranteed, not obligations of any bank, thrift or other entity and are not insured by the FDIC.

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