Fixed Income and Credit Risk

This document provides an in-depth discussion on the subject of bond interest structure, forwards rates and bonds spread with the objective of selecting two bonds issuer who shall have both the elements of corporates and two sovereign nations European Bank for Reconstruction and Development and Deutsche Bank AG.

Running head: FIXED INCOME AND CREDIT RISK
Fixed Income and Credit Risk
Name of the Student:
Name of the University:
Authors Note:

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FIXED INCOME AND CREDIT RISK
Contents
Introduction:....................................................................................................................................2
Part 1:...............................................................................................................................................2
Part 2:.............................................................................................................................................10
Part 3:.............................................................................................................................................21
Part 4:.............................................................................................................................................37

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FIXED INCOME AND CREDIT RISK
Introduction:
In order to provide in-depth discussion on the subject of bond interest structure, forwards
rates and bonds spread it is firstly essential to select two different bond issuers. The document
brief has asked to consider two bonds of sovereign nations or use two corporate bonds. However,
with the objective of selecting two bonds issuer who shall have both the elements of corporates
and two sovereign nations European Bank for Reconstruction and Development and Deutsche
Bank AG have been selected. Detailed discussion on the bonds issued by the two different
financial institutes from different countries have been made here with the objective of providing
necessary information to the readers on different elements of bonds.
Part 1:
Firstly let’s have the brief details about the bonds issued by European Bank for
Reconstruction and Development and Deutsche Bank AG. A clear understanding about the terms
and conditions of the bonds issued by the European Bank for Reconstruction and Development,
here in after to be referred to as EBRD only in this document and Deutsche Bank AG, here in
after to be referred to as Deutsche only in this document shall helpful in estimating the interest
structures, calculate forward rates and comment on the spread (Du, Tepper and Verdelhan,
2018).
The table below contains the information about the bonds issued by EBRD.

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FIXED INCOME AND CREDIT RISK
EBRD in order to finance the requirements of fund to the tune of 1,500,000,000 Russian Rouble
(RUB) issued international bonds with nominal amount of 50,000 RUB per bond. As can be seen
that the coupon rate of the bonds is 7.25% per annum with annual coupon frequency (Malkiel,
2015). The discounted rate to be used is the LIBOR +2% to calculate the present value of the
bond and subsequently the forward rate. The interest structure of the above bond for EBRD is
provided below.
Interest structure of EBRD (RUB bond issuer)
Interest
structur
e of
bond
Deutsche
Years Bond amount (RUB) Coupon rate (A): Interest (B): PV factors Term structure

4
FIXED INCOME AND CREDIT RISK
(7.25%) (RUB) @5.25% (AxB)
1 1,500,000,000.00 7.25% 108,750,000.00 0.950119 103,325,415.68
2 1,500,000,000.00 7.25% 108,750,000.00 0.902726 98,171,416.32
3 1,500,000,000.00 7.25% 108,750,000.00 0.857697 93,274,504.82
4 1,500,000,000.00 7.25% 108,750,000.00 0.814914 88,621,857.31
5 1,500,000,000.00 7.25% 108,750,000.00 0.774265 84,201,289.60
6 1,500,000,000.00 7.25% 108,750,000.00 0.735643 80,001,225.28
7 1,500,000,000.00 7.25% 108,750,000.00 0.698949 76,010,665.35
8 1,500,000,000.00 7.25% 108,750,000.00 0.664084 72,219,159.47
9 1,500,000,000.00 7.25% 108,750,000.00 0.630959 68,616,778.60
10 1,500,000,000.00 7.25% 108,750,000.00 0.599486 65,194,088.93
11 1,500,000,000.00 7.25% 108,750,000.00 0.569583 61,942,127.25
12 1,500,000,000.00 7.25% 108,750,000.00 0.541171 58,852,377.43
13 1,500,000,000.00 7.25% 108,750,000.00 0.514177 55,916,748.16
14 1,500,000,000.00 7.25% 108,750,000.00 0.488529 53,127,551.69
15 1,500,000,000.00 7.25% 108,750,000.00 0.464161 50,477,483.79
16 1,500,000,000.00 7.25% 108,750,000.00 0.441008 47,959,604.55

5
FIXED INCOME AND CREDIT RISK
17 1,500,000,000.00 7.25% 108,750,000.00 0.41901 45,567,320.24
18 1,500,000,000.00 7.25% 108,750,000.00 0.398109 43,294,366.02
19 1,500,000,000.00 7.25% 108,750,000.00 0.378251 41,134,789.57
20 1,500,000,000.00 7.25% 108,750,000.00 0.359383 39,082,935.46
21 1,500,000,000.00 7.25% 108,750,000.00 0.341457 37,133,430.37
22 1,500,000,000.00 7.25% 108,750,000.00 0.324425 35,281,168.99
23 1,500,000,000.00 7.25% 108,750,000.00 0.308242 33,521,300.71
24 1,500,000,000.00 7.25% 108,750,000.00 0.292866 31,849,216.82
25 1,500,000,000.00 7.25% 108,750,000.00 0.278258 30,260,538.55
26 1,500,000,000.00 7.25% 108,750,000.00 0.264378 28,751,105.51
27 1,500,000,000.00 7.25% 108,750,000.00 0.25119 27,316,964.86
28 1,500,000,000.00 7.25% 108,750,000.00 0.238661 25,954,360.91
29 1,500,000,000.00 7.25% 108,750,000.00 0.226756 24,659,725.33
30 1,500,000,000.00 7.25% 108,750,000.00 0.215445 23,429,667.77

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FIXED INCOME AND CREDIT RISK
Deutsche has issued bonds denominated IDR (Indonesian Rupiah) to arrange 1,470,000,000 IDR
from issue of bonds with 9% coupon rate (Schwarz, 2017). The details regarding the bonds
issued by the Deutsche is provided in the table below:
As per the above terms and conditions of Deutsche the interest structure will be as following:
Interest structure of Deutsche
Years Bond amount
(IDR)
Coupon rate
(9%)
Interest (RUB) (B): PV factors
@5.25%
Term structure
(A x B)
1 1,470,000,000.00 9.00% 132,300,000.
00
0.950119 125,700,712.
59
2 1,470,000,000.00 9.00% 132,300,000.
00
0.902726 119,430,605.
79
3 1,470,000,000.00 9.00% 132,300,000. 0.857697 113,473,259.

7
FIXED INCOME AND CREDIT RISK
00 65
4 1,470,000,000.00 9.00% 132,300,000.
00
0.814914 107,813,073.
31
5 1,470,000,000.00 9.00% 132,300,000.
00
0.774265 102,435,224.
04
6 1,470,000,000.00 9.00% 132,300,000.
00
0.735643 97,325,628.
54
7 1,470,000,000.00 9.00% 132,300,000.
00
0.698949 92,470,905.
98
8 1,470,000,000.00 9.00% 132,300,000.
00
0.664084 87,858,342.
97
9 1,470,000,000.00 9.00% 132,300,000.
00
0.630959 83,475,860.
31
10 1,470,000,000.00 9.00% 132,300,000.
00
0.599486 79,311,981.
29
11 1,470,000,000.00 9.00% 132,300,000.
00
0.569583 75,355,801.
70
12 1,470,000,000.00 9.00% 132,300,000.
00
0.541171 71,596,961.
24
13 1,470,000,000.00 9.00% 132,300,000. 0.514177 68,025,616.

8
FIXED INCOME AND CREDIT RISK
00 38
14 1,470,000,000.00 9.00% 132,300,000.
00
0.488529 64,632,414.
61
15 1,470,000,000.00 9.00% 132,300,000.
00
0.464161 61,408,469.
94
16 1,470,000,000.00 9.00% 132,300,000.
00
0.441008 58,345,339.
61
17 1,470,000,000.00 9.00% 132,300,000.
00
0.41901 55,435,002.
00
18 1,470,000,000.00 9.00% 132,300,000.
00
0.398109 52,669,835.
63
19 1,470,000,000.00 9.00% 132,300,000.
00
0.378251 50,042,599.
18
20 1,470,000,000.00 9.00% 132,300,000.
00
0.359383 47,546,412.
52
21 1,470,000,000.00 9.00% 132,300,000.
00
0.341457 45,174,738.
73
22 1,470,000,000.00 9.00% 132,300,000.
00
0.324425 42,921,366.
97
23 1,470,000,000.00 9.00% 132,300,000. 0.308242 40,780,396.

9
FIXED INCOME AND CREDIT RISK
00 17
24 1,470,000,000.00 9.00% 132,300,000.
00
0.292866 38,746,219.
64
25 1,470,000,000.00 9.00% 132,300,000.
00
0.278258 36,813,510.
35
26 1,470,000,000.00 9.00% 132,300,000.
00
0.264378 34,977,206.
98
27 1,470,000,000.00 9.00% 132,300,000.
00
0.25119 33,232,500.
69
28 1,470,000,000.00 9.00% 132,300,000.
00
0.238661 31,574,822.
51
29 1,470,000,000.00 9.00% 132,300,000.
00
0.226756 29,999,831.
36
30 1,470,000,000.00 9.00% 132,300,000.
00
0.215445 28,503,402.
72
Part 2:
Forward rates of bonds:
There are different types of bonds which are issued by the corporations, governments and
financial institutions. Such bonds include zero coupon bond, bonds carrying fixed interests and

10
FIXED INCOME AND CREDIT RISK
flexible bonds. Also bonds can be classified on the basis of characteristics of issuers, i.e.
Government bonds and corporate bonds (Wu and Xia, 2017).
Forward rates of zero coupon bonds are calculated by using the following formula:
The cash flows in zero coupon bonds are takes place twice only, once at the time of issue of
bonds and at the time of repayment of bonds. The present value factor, generally the market
interest rates, used to calculate the present value of cash flow to calculate forward rate of zero
coupon bonds. Following table indicates use of present value factor to discount the cash flows to
calculate the forward rate of zero coupon bond.
To calculate the forward rate of fixed coupon bond the following formula is used:

11
FIXED INCOME AND CREDIT RISK
The interest rate can be locked with the (rn) for investing money for n number of years.
Algebraically the equation can be rearranged as following to calculate the forward rate of fixed
interest bond (Kung, 2015).
The above has to be applied repeatedly to find the value to the following equation:
Forward rate of EBRD bond:
Taking into consideration the discussion above the forward rate of EBRD bond shall be
calculated by using fixed coupon rate formula. It is important to note that the coupon rate in case
of EBRD bond is 7.25% as can be seen and it is fixed as per the terms and conditions provided in
the bond issue template provided at the beginning of the document (Borio, McCauley, McGuire
and Sushko, 2016). Accordingly, the following formula has been used to calculate forward rate
of fixed coupon EBRD bond:

12
FIXED INCOME AND CREDIT RISK
Using the above formula the forward rate of EBRD bond is 1.0455.
Forward rate Deutsche bond:
Again the bond denominated in IDR to collect necessary funds by Deutsche a 9% fixed coupon
bond has been issued. Using the fixed coupon formula the forward rate for the bond is calculated
below.
The forward rate of Deutsche bond is 1.055.
The difference between the forward rates is (1.055- 1.0455) = 0.0095.
The present value of interest spread over the maturity period of bond is calculated by using the
simple excel format for the benefit of the readers. The present value of maturity amount of each
bond has been calculated and added with the total present value of coupon interest to calculate
the value of the bond at the date of issue of the bond (Campbell, Sunderam and Viceira, 2017).
EBRD
Years Bond amount Coupon rate (A): Interest (B): PV factors Term structure

13
FIXED INCOME AND CREDIT RISK
(RUB) (7.25%) (RUB) @5.25% (AxB)
1
50,000.00
7.25%
3,625.00
0.950119
3,444.18
2
50,000.00
7.25%
3,625.00
0.902726
3,272.38
3
50,000.00
7.25%
3,625.00
0.857697
3,109.15
4
50,000.00
7.25%
3,625.00
0.814914
2,954.06
5
50,000.00
7.25%
3,625.00
0.774265
2,806.71
6
50,000.00
7.25%
3,625.00
0.735643
2,666.71
7
50,000.00
7.25%
3,625.00
0.698949
2,533.69
8
50,000.00
7.25%
3,625.00
0.664084
2,407.31
9
50,000.00
7.25%
3,625.00
0.630959
2,287.23
10 7.25% 0.599486

14
FIXED INCOME AND CREDIT RISK
50,000.00 3,625.00 2,173.14
11
50,000.00
7.25%
3,625.00
0.569583
2,064.74
12
50,000.00
7.25%
3,625.00
0.541171
1,961.75
13
50,000.00
7.25%
3,625.00
0.514177
1,863.89
14
50,000.00
7.25%
3,625.00
0.488529
1,770.92
15
50,000.00
7.25%
3,625.00
0.464161
1,682.58
16
50,000.00
7.25%
3,625.00
0.441008
1,598.65
17
50,000.00
7.25%
3,625.00
0.41901
1,518.91
18
50,000.00
7.25%
3,625.00
0.398109
1,443.15
19
50,000.00
7.25%
3,625.00
0.378251
1,371.16
20 7.25% 0.359383

15
FIXED INCOME AND CREDIT RISK
50,000.00 3,625.00 1,302.76
21
50,000.00
7.25%
3,625.00
0.341457
1,237.78
22
50,000.00
7.25%
3,625.00
0.324425
1,176.04
23
50,000.00
7.25%
3,625.00
0.308242
1,117.38
24
50,000.00
7.25%
3,625.00
0.292866
1,061.64
25
50,000.00
7.25%
3,625.00
0.278258
1,008.68
26
50,000.00
7.25%
3,625.00
0.264378
958.37
27
50,000.00
7.25%
3,625.00
0.25119
910.57
28
50,000.00
7.25%
3,625.00
0.238661
865.15
29
50,000.00
7.25%
3,625.00
0.226756
821.99
30 7.25% 0.215445

16
FIXED INCOME AND CREDIT RISK
50,000.00 3,625.00 780.99
Present value interest
54,171.64
Add: Present value of repayment (50000 x 0.215445)
10,772.26
Present value of EBRD bond
64,943.90
Thus, present value of EBRD Bond is 64,943.90 RBU for the investors. Thus investing in the
bond is a profitable option from the point view of the investors (Miyajima, Mohanty and Chan,
2015).
Similarly the present value of Deutsche bond issued by the bank with 9% coupon rate is
calculated below.
Years Bond amount
(IDR)
Coupon
rate
(9%)
Interest
(RUB)
(B): PV
factors
@5.25%
Term structure
(AxB)
1
100,000,000.00
9.00%
9,000,000.00
0.950119
8,551,068.88
2 9.00% 0.902726

17
FIXED INCOME AND CREDIT RISK
100,000,000.00 9,000,000.00 8,124,531.01
3
100,000,000.00
9.00%
9,000,000.00
0.857697
7,719,269.36
4
100,000,000.00
9.00%
9,000,000.00
0.814914
7,334,222.67
5
100,000,000.00
9.00%
9,000,000.00
0.774265
6,968,382.59
6
100,000,000.00
9.00%
9,000,000.00
0.735643
6,620,791.06
7
100,000,000.00
9.00%
9,000,000.00
0.698949
6,290,537.82
8
100,000,000.00
9.00%
9,000,000.00
0.664084
5,976,758.03
9
100,000,000.00
9.00%
9,000,000.00
0.630959
5,678,629.95
10
100,000,000.00
9.00%
9,000,000.00
0.599486
5,395,372.88
11
100,000,000.00
9.00%
9,000,000.00
0.569583
5,126,245.01
12 9.00% 0.541171

18
FIXED INCOME AND CREDIT RISK
100,000,000.00 9,000,000.00 4,870,541.58
13
100,000,000.00
9.00%
9,000,000.00
0.514177
4,627,592.95
14
100,000,000.00
9.00%
9,000,000.00
0.488529
4,396,762.90
15
100,000,000.00
9.00%
9,000,000.00
0.464161
4,177,446.93
16
100,000,000.00
9.00%
9,000,000.00
0.441008
3,969,070.72
17
100,000,000.00
9.00%
9,000,000.00
0.41901
3,771,088.57
18
100,000,000.00
9.00%
9,000,000.00
0.398109
3,582,982.02
19
100,000,000.00
9.00%
9,000,000.00
0.378251
3,404,258.45
20
100,000,000.00
9.00%
9,000,000.00
0.359383
3,234,449.83
21
100,000,000.00
9.00%
9,000,000.00
0.341457
3,073,111.48
22 9.00% 0.324425

19
FIXED INCOME AND CREDIT RISK
100,000,000.00 9,000,000.00 2,919,820.88
23
100,000,000.00
9.00%
9,000,000.00
0.308242
2,774,176.61
24
100,000,000.00
9.00%
9,000,000.00
0.292866
2,635,797.25
25
100,000,000.00
9.00%
9,000,000.00
0.278258
2,504,320.43
26
100,000,000.00
9.00%
9,000,000.00
0.264378
2,379,401.84
27
100,000,000.00
9.00%
9,000,000.00
0.25119
2,260,714.33
28
100,000,000.00
9.00%
9,000,000.00
0.238661
2,147,947.11
29
100,000,000.00
9.00%
9,000,000.00
0.226756
2,040,804.85
30
100,000,000.00
9.00%
9,000,000.00
0.215445
1,939,006.99
Present value total
interest 134,495,104.99

20
FIXED INCOME AND CREDIT RISK
Add: Present value of principal(100,000,000 x
0.215445) 21,544,522.09
Present value of Deutsche Bond
156,039,627.08
As can be seen from the above that the investors by investing 100,000,000 IDR in Deutsche bond
expected to receive a present value of 156,039,627.08 IDR over the life time of the bond. Hence,
from the point of view of investors the proposal of investing in the bonds issued by Deutsche is a
profitable investment proposal (Hanson and Stein, 2015).
Part 3:
The spread is calculated to show the yield expected to be earned over the life time of a
bond. In this case the present value of bond from the point of view of investors, in both case,
show that the investors are expected to earn significant amount of return by investing in the bond
of EBRD and Deutsche. The method used here is relatively simple to find out the present value
of interest to be earned by the investors on the bond over the useful life of the bond (Rachel and
Smith, 2015). The coupon rate of bonds, i.e. 7.25% for EBRD RBU bond and 9% for Deutsche
IDR bond are fixed. Hence, there is no question fluctuation in the actual spread and yield of
bonds throughout the life time of the bond. Thus, there is no confusion regarding the periodic
coupon to be received from the bond (Du, Tepper and Verdelhan, 2018). However, in order to
calculate the present value of coupon as well as the principal to be rapid at the end of the
maturity period of the respective bonds it is important to use an appropriate rate of interest.

21
FIXED INCOME AND CREDIT RISK
5.25% has been used, i.e. LIBOR plus 2% to calculate the present value of interest and the
principal amount to calculate the present value of respective bonds (Liao, 2016).
It is important to keep in mind that LIBOR is not going to stay at 3.25% throughout the useful
life of the bonds thus, the calculation of present value of interest spreads and bonds will not be
completely correct (Borio et. al. 2016). Taking into consideration this constraint the present
value of interests spreads is calculated in the table below by using simple formula in the table
below:
Present value of Interest spreads for the EBRD bond:
Years Bond amount
(RUB)
Coupon
rate
(7.25%)
(A): Interest
(RUB)
(B): PV
factors
@5.25%
Term structure (A x B)
1 50,000.
00
7.25% 3,625.
00
0.950119 3,444.18
2 50,000.
00
7.25% 3,625.
00
0.902726 3,272.38
3 50,000.
00
7.25% 3,625.
00
0.857697 3,109.15
4 50,000.
00
7.25% 3,625.
00
0.814914 2,954.06
5 50,000. 7.25% 3,625. 0.774265 2,806.71

22
FIXED INCOME AND CREDIT RISK
00 00
6 50,000.
00
7.25% 3,625.
00
0.735643 2,666.71
7 50,000.
00
7.25% 3,625.
00
0.698949 2,533.69
8 50,000.
00
7.25% 3,625.
00
0.664084 2,407.31
9 50,000.
00
7.25% 3,625.
00
0.630959 2,287.23
10 50,000.
00
7.25% 3,625.
00
0.599486 2,173.14
11 50,000.
00
7.25% 3,625.
00
0.569583 2,064.74
12 50,000.
00
7.25% 3,625.
00
0.541171 1,961.75
13 50,000.
00
7.25% 3,625.
00
0.514177 1,863.89
14 50,000.
00
7.25% 3,625.
00
0.488529 1,770.92
15 50,000. 7.25% 3,625. 0.464161 1,682.58

23
FIXED INCOME AND CREDIT RISK
00 00
16 50,000.
00
7.25% 3,625.
00
0.441008 1,598.65
17 50,000.
00
7.25% 3,625.
00
0.41901 1,518.91
18 50,000.
00
7.25% 3,625.
00
0.398109 1,443.15
19 50,000.
00
7.25% 3,625.
00
0.378251 1,371.16
20 50,000.
00
7.25% 3,625.
00
0.359383 1,302.76
21 50,000.
00
7.25% 3,625.
00
0.341457 1,237.78
22 50,000.
00
7.25% 3,625.
00
0.324425 1,176.04
23 50,000.
00
7.25% 3,625.
00
0.308242 1,117.38
24 50,000.
00
7.25% 3,625.
00
0.292866 1,061.64
25 50,000. 7.25% 3,625. 0.278258 1,008.68

24
FIXED INCOME AND CREDIT RISK
00 00
26 50,000.
00
7.25% 3,625.
00
0.264378 958.37
27 50,000.
00
7.25% 3,625.
00
0.25119 910.57
28 50,000.
00
7.25% 3,625.
00
0.238661 865.15
29 50,000.
00
7.25% 3,625.
00
0.226756 821.99
30 50,000.
00
7.25% 3,625.
00
0.215445 780.99
Present value of interest spread for the Deutsche bond is calculated below:
Years Bond amount (IDR) Coupon
rate (9%)
Interest (RUB) (B): PV
factors
@5.25%
Term structure (AxB)
1 100,000,000.00 9.00% 9,000,000.0
0
0.950119 8,551,068.88
2 100,000,000.00 9.00% 9,000,000.0 0.902726 8,124,531.01

25
FIXED INCOME AND CREDIT RISK
0
3 100,000,000.00 9.00% 9,000,000.0
0
0.857697 7,719,269.36
4 100,000,000.00 9.00% 9,000,000.0
0
0.814914 7,334,222.67
5 100,000,000.00 9.00% 9,000,000.0
0
0.774265 6,968,382.59
6 100,000,000.00 9.00% 9,000,000.0
0
0.735643 6,620,791.06
7 100,000,000.00 9.00% 9,000,000.0
0
0.698949 6,290,537.82
8 100,000,000.00 9.00% 9,000,000.0
0
0.664084 5,976,758.03
9 100,000,000.00 9.00% 9,000,000.0
0
0.630959 5,678,629.95
10 100,000,000.00 9.00% 9,000,000.0
0
0.599486 5,395,372.88
11 100,000,000.00 9.00% 9,000,000.0
0
0.569583 5,126,245.01
12 100,000,000.00 9.00% 9,000,000.0 0.541171 4,870,541.58

26
FIXED INCOME AND CREDIT RISK
0
13 100,000,000.00 9.00% 9,000,000.0
0
0.514177 4,627,592.95
14 100,000,000.00 9.00% 9,000,000.0
0
0.488529 4,396,762.90
15 100,000,000.00 9.00% 9,000,000.0
0
0.464161 4,177,446.93
16 100,000,000.00 9.00% 9,000,000.0
0
0.441008 3,969,070.72
17 100,000,000.00 9.00% 9,000,000.0
0
0.41901 3,771,088.57
18 100,000,000.00 9.00% 9,000,000.0
0
0.398109 3,582,982.02
19 100,000,000.00 9.00% 9,000,000.0
0
0.378251 3,404,258.45
20 100,000,000.00 9.00% 9,000,000.0
0
0.359383 3,234,449.83
21 100,000,000.00 9.00% 9,000,000.0
0
0.341457 3,073,111.48
22 100,000,000.00 9.00% 9,000,000.0 0.324425 2,919,820.88

27
FIXED INCOME AND CREDIT RISK
0
23 100,000,000.00 9.00% 9,000,000.0
0
0.308242 2,774,176.61
24 100,000,000.00 9.00% 9,000,000.0
0
0.292866 2,635,797.25
25 100,000,000.00 9.00% 9,000,000.0
0
0.278258 2,504,320.43
26 100,000,000.00 9.00% 9,000,000.0
0
0.264378 2,379,401.84
27 100,000,000.00 9.00% 9,000,000.0
0
0.25119 2,260,714.33
28 100,000,000.00 9.00% 9,000,000.0
0
0.238661 2,147,947.11
29 100,000,000.00 9.00% 9,000,000.0
0
0.226756 2,040,804.85
30 100,000,000.00 9.00% 9,000,000.0
0
0.215445 1,939,006.99
However, as already mentioned that the reliability of the above data is questionable because to
expect that LIBOR would remain at 3.25% over the course of 30 years, i.e. time after which the

28
FIXED INCOME AND CREDIT RISK
respective bonds shall be matured will be extremely naïve from financial view point. Thus, in
order to address the concern of the investors it would be beneficial to calculate the present value
of spreads by using different LIBOR rates. This will enable the investors to understand the
expected outcome of investing in the bond even if the market rate of interest changes in the
future (Ismailov and Rossi, 2018).
As already mentioned that the benefit of calculating the present value of spreads of bonds as well
as present value of bond is that the periodical coupon amount does not change. In this case the
annual interest on Deutsche and EBRD bond will remain at 9% and 7.25% of the nominal
amount of bond. Thus, to compensate the future uncertainty in market rate of interest little
adjustments to the LIBOR will be helpful in calculating the present value of spreads.
Accordingly, the present value of spread is calculated for both bonds by using different LIBOR
(Sushko et. al. 2017).
In case the LIBOR changes in the future to 3.75% instead of 3.25%. As the discount rate has
been taken at LIBOR plus 2% thus, the present value of interests spreads for EBRD bond is
shown in the table below:
Years Bond amount
(RUB)
Coupon
rate
(7.25%)
(A): Interest
(RUB)
(B): PV
factors
@5.75%
Term structure (AxB)
1 50,00
0.00
7.25% 3,62
5.00
0.945626 3,427.90
2 50,00 7.25% 3,62 0.894209 3,241.51

29
FIXED INCOME AND CREDIT RISK
0.00 5.00
3 50,00
0.00
7.25% 3,62
5.00
0.845588 3,065.26
4 50,00
0.00
7.25% 3,62
5.00
0.799611 2,898.59
5 50,00
0.00
7.25% 3,62
5.00
0.756133 2,740.98
6 50,00
0.00
7.25% 3,62
5.00
0.715019 2,591.94
7 50,00
0.00
7.25% 3,62
5.00
0.676141 2,451.01
8 50,00
0.00
7.25% 3,62
5.00
0.639377 2,317.74
9 50,00
0.00
7.25% 3,62
5.00
0.604612 2,191.72
10 50,00
0.00
7.25% 3,62
5.00
0.571737 2,072.55
11 50,00
0.00
7.25% 3,62
5.00
0.54065 1,959.85
12 50,00 7.25% 3,62 0.511253 1,853.29

30
FIXED INCOME AND CREDIT RISK
0.00 5.00
13 50,00
0.00
7.25% 3,62
5.00
0.483454 1,752.52
14 50,00
0.00
7.25% 3,62
5.00
0.457167 1,657.23
15 50,00
0.00
7.25% 3,62
5.00
0.432309 1,567.12
16 50,00
0.00
7.25% 3,62
5.00
0.408803 1,481.91
17 50,00
0.00
7.25% 3,62
5.00
0.386575 1,401.33
18 50,00
0.00
7.25% 3,62
5.00
0.365555 1,325.14
19 50,00
0.00
7.25% 3,62
5.00
0.345679 1,253.09
20 50,00
0.00
7.25% 3,62
5.00
0.326883 1,184.95
21 50,00
0.00
7.25% 3,62
5.00
0.309109 1,120.52
22 50,00 7.25% 3,62 0.292302 1,059.59

31
FIXED INCOME AND CREDIT RISK
0.00 5.00
23 50,00
0.00
7.25% 3,62
5.00
0.276408 1,001.98
24 50,00
0.00
7.25% 3,62
5.00
0.261379 947.50
25 50,00
0.00
7.25% 3,62
5.00
0.247167 895.98
26 50,00
0.00
7.25% 3,62
5.00
0.233728 847.26
27 50,00
0.00
7.25% 3,62
5.00
0.221019 801.19
28 50,00
0.00
7.25% 3,62
5.00
0.209002 757.63
29 50,00
0.00
7.25% 3,62
5.00
0.197637 716.44
30 50,00
0.00
7.25% 3,62
5.00
0.186891 677.48
Similarly with LIBOR rate of 3.75% instead of 3.25% the present value of interests spreads for
bond issued Deutsche is calculated in the table below:

32
FIXED INCOME AND CREDIT RISK
Years Bond amount
(IDR)
Coupon
rate
(9%)
Interest
(RUB)
(B): PV
factors
@5.75%
Term structure
(AxB)
1 100,000,00
0.00
9.00% 9,000,00
0.00
0.945626 8,510,63
8.30
2 100,000,00
0.00
9.00% 9,000,00
0.00
0.894209 8,047,88
4.92
3 100,000,00
0.00
9.00% 9,000,00
0.00
0.845588 7,610,29
3.06
4 100,000,00
0.00
9.00% 9,000,00
0.00
0.799611 7,196,49
4.62
5 100,000,00
0.00
9.00% 9,000,00
0.00
0.756133 6,805,19
5.86
6 100,000,00
0.00
9.00% 9,000,00
0.00
0.715019 6,435,17
3.39
7 100,000,00
0.00
9.00% 9,000,00
0.00
0.676141 6,085,27
0.35
8 100,000,00
0.00
9.00% 9,000,00
0.00
0.639377 5,754,39
2.76
9 100,000,00 9.00% 9,000,00 0.604612 5,441,50

33
FIXED INCOME AND CREDIT RISK
0.00 0.00 6.16
10 100,000,00
0.00
9.00% 9,000,00
0.00
0.571737 5,145,63
2.30
11 100,000,00
0.00
9.00% 9,000,00
0.00
0.54065 4,865,84
6.15
12 100,000,00
0.00
9.00% 9,000,00
0.00
0.511253 4,601,27
2.95
13 100,000,00
0.00
9.00% 9,000,00
0.00
0.483454 4,351,08
5.53
14 100,000,00
0.00
9.00% 9,000,00
0.00
0.457167 4,114,50
1.69
15 100,000,00
0.00
9.00% 9,000,00
0.00
0.432309 3,890,78
1.74
16 100,000,00
0.00
9.00% 9,000,00
0.00
0.408803 3,679,22
6.23
17 100,000,00
0.00
9.00% 9,000,00
0.00
0.386575 3,479,17
3.74
18 100,000,00
0.00
9.00% 9,000,00
0.00
0.365555 3,289,99
8.81
19 100,000,00 9.00% 9,000,00 0.345679 3,111,10

34
FIXED INCOME AND CREDIT RISK
0.00 0.00 9.98
20 100,000,00
0.00
9.00% 9,000,00
0.00
0.326883 2,941,94
7.98
21 100,000,00
0.00
9.00% 9,000,00
0.00
0.309109 2,781,98
3.90
22 100,000,00
0.00
9.00% 9,000,00
0.00
0.292302 2,630,71
7.64
23 100,000,00
0.00
9.00% 9,000,00
0.00
0.276408 2,487,67
6.25
24 100,000,00
0.00
9.00% 9,000,00
0.00
0.261379 2,352,41
2.53
25 100,000,00
0.00
9.00% 9,000,00
0.00
0.247167 2,224,50
3.58
26 100,000,00
0.00
9.00% 9,000,00
0.00
0.233728 2,103,54
9.48
27 100,000,00
0.00
9.00% 9,000,00
0.00
0.221019 1,989,17
2.09
28 100,000,00
0.00
9.00% 9,000,00
0.00
0.209002 1,881,01
3.79
29 100,000,00 9.00% 9,000,00 0.197637 1,778,73

35
FIXED INCOME AND CREDIT RISK
0.00 0.00 6.45
30 100,000,00
0.00
9.00% 9,000,00
0.00
0.186891 1,682,02
0.28
The above steps can be repeated by as many times as required by using different discount rates to
increase the reliability of the calculations made using the above method (Kaufman and
Hopewell, 2017).
The spread above does reflect the way that the short term spread between the two issuers is likely
to move.
Part 4:
The trading strategy can be very effectively designed and generated by using the above method.
It is because the above method would give the investors and traders complete analysis about the
expected returns in different years along with the present value of cash inflows from the
investment over the life period of respective bonds (Hawawini, 2017). In addition the investors
and traders would be able to calculate the expected present value of different investment options
to determine whether to invest in a particular investment option or not. Also sensitivity analysis
can be conducted by using different underlying variables to compensate for the uncertain future
(Hawawini, 2017).
Trading strategy and design for the investors:
With LIBOR 3.25%:

36
FIXED INCOME AND CREDIT RISK
For EBRD bond:
The present value of EBRD bond is 64,943.90 RUB with nominal value of the bond is 50,000
RUB hence, investors should certainly invest in the bond in case the above circumstances persist
in the future (Schlarbaum, Racette and Boquist, 2017).
For Deutsche bond:
The present value of Deutsche bond is 156,039,627.08 with discount rate of 5.25% (LIBOR
3.25% + 2%) is significantly higher than the Nominal value of the bond hence, the option
provides significant opportunity to earn substantial return on the amount of investment in the
bond. Hence, the investor should invest in the bond (Schlarbaum, Racette and Boquist, 2017).

37
FIXED INCOME AND CREDIT RISK
References:
Borio, C.E., McCauley, R.N., McGuire, P. and Sushko, V., 2016. Covered interest parity lost:
understanding the cross-currency basis.
Borio, C.E., McCauley, R.N., McGuire, P. and Sushko, V., 2016. Covered interest parity lost:
understanding the cross-currency basis.
Campbell, J.Y., Sunderam, A. and Viceira, L.M., 2017. Inflation bets or deflation hedges? the
changing risks of nominal bonds. Critical Finance Review, 6(2), pp.263-301.
Du, W., Tepper, A. and Verdelhan, A., 2018. Deviations from covered interest rate parity. The
Journal of Finance, 73(3), pp.915-957.
Du, W., Tepper, A. and Verdelhan, A., 2018. Deviations from covered interest rate parity. The
Journal of Finance, 73(3), pp.915-957.
Hanson, S.G. and Stein, J.C., 2015. Monetary policy and long-term real rates. Journal of
Financial Economics, 115(3), pp.429-448. Hanson, S.G. and Stein, J.C., 2015. Monetary policy
and long-term real rates. Journal of Financial Economics, 115(3), pp.429-448.
Hawawini, G., 2017. Bond Duration and Immunization: Early Developments and Recent
Contributions. Routledge. Available at:
https://www.taylorfrancis.com/books/e/9781351381116/chapters/10.4324%2F9781315145976-1
[Accessed on 15 November 2018]
Hawawini, G., 2017. The Mathematics of Macaulay’s Duration. In Bond Duration and
Immunization (pp. 47-55). Routledge.

38
FIXED INCOME AND CREDIT RISK
Ismailov, A. and Rossi, B., 2018. Uncertainty and deviations from uncovered interest rate
parity. Journal of International Money and Finance, 88, pp.242-259.
Kaufman, G.G. and Hopewell, M.H., 2017. Bond price volatility and term to maturity: A
generalized respecification. In Bond Duration and Immunization (pp. 64-68). Routledge.
Available at:
https://www.taylorfrancis.com/books/e/9781351381116/chapters/10.4324%2F9781315145976-5
[Accessed on 15 November 2018]
Kung, H., 2015. Macroeconomic linkages between monetary policy and the term structure of
interest rates. Journal of Financial Economics, 115(1), pp.42-57.
Liao, G.Y., 2016. Credit migration and covered interest rate parity. Project on Behavioral
Finance and Financial Stability Working Paper Series,(2016-07).
Malkiel, B.G., 2015. Term structure of interest rates: expectations and behavior patterns.
Princeton University Press.
Miyajima, K., Mohanty, M.S. and Chan, T., 2015. Emerging market local currency bonds:
diversification and stability. Emerging Markets Review, 22, pp.126-139.
Rachel, L. and Smith, T., 2015. Secular drivers of the global real interest rate.
Schlarbaum, G.G., Racette, G.A. and Boquist, J.A., 2017. Duration and Risk Assessment for
Bonds and Common Stocks. In Bond Duration and Immunization (pp. 102-107). Routledge.
Available at: https://content.taylorfrancis.com/books/e/download?dac=C2017-0-55182-
X&isbn=9781315145976&doi=10.4324/9781315145976-8&format=pdf [Accessed on 15
November 2018]

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FIXED INCOME AND CREDIT RISK
Schwarz, K., 2017. Mind the gap: Disentangling credit and liquidity in risk spreads.
Sushko, V., Borio, C.E., McCauley, R.N. and McGuire, P., 2017. The failure of covered interest
parity: FX hedging demand and costly balance sheets.
Wu, J.C. and Xia, F.D., 2017. Time-varying lower bound of interest rates in Europe.