Matrix Pricing of bonds

[Anand Singh]

Hi,
Can anyone explain matrix pricing of bonds with an example? I am having a tough time understanding it on my own.

 

[Ernest Seow]

Anand Singh wrote:
Hi,
Can anyone explain matrix pricing of bonds with an example? I am having a tough time understanding it on my own.

Hello,
Consider the following:

• 5 year, 5% annual pay coupon bond with YTM= ???

Comparing this bond with the following bonds:

• 6 year, 5% annual pay coupon bond, with YTM= 6%
• 4 year, 5% annual pay coupon bond, with YTM= 5.5%

This is how it will look like:
l_________________l__________________l
4 year 5 year 6 year
5.5% 6%
Using linear interpolation,
YTM (of the bond in question)= 5.5% + [ (5-4)/(6-4) * (6%-5.5%) ]= 5.75%
Since 5 year is the mid point of 4 year and 6 year, an alternative method will be to take the simple average of the two YTM (i.e. 5.5% and 6%).
Hope it helps a bit.
Cheers,
Ernest

 

[edupristine]

Matrix prices are quoted prices for securities with same maturities and ratings rather than a fix price for desigmated security . Matrix means interpolating in the matrix format.They are used under highly liquid positions.

 

[Anand Singh]

Thanks guys …