Hi,
Can anyone explain matrix pricing of bonds with an example? I am having a tough time understanding it on my own.
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:
Comparing this bond with the following bonds:
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
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.
Thanks guys …
Why linear interpolation is used??
Because it’s easy.
I mean why we’re not using the average?
Linear interpolation _ is _ an average: a weighted average.
If you know the price of a 1-year bond and the price of a 5-year bond, but not the prices of any bonds with maturities between 1 year and 5 years, would you use the same (unweighted average) price for a 2-year bond, a 3-year bond, and a 4-year bond?
Got it. Thank you.
You’re quite welcome.
is there any hard and fast formulae for linear interpolation?
What do you mean ? Linear interpolation is unitary method. What could be harder than that ?
Yes.