Brady Valuation Tutorial
session 1.
Introduction to Stripped Yield and Sovereign Spread
Brady Market versus Traditional Bond Market
Valuing a
Simple Five-Period Bond with Principal Collateral
Calculating
Stripped Yield and Sovereign Spread
Class
Problems
How the Brady market differs from more traditional bond
markets:
Traditional bond markets:
- Most bonds have a fixed coupon
- Floating-rate bonds tend to trade
- "Unusual" features are unusual
- No collateral
Brady bond market:
- About half the traded issues have a floating
coupon
- Fixed- and floating-rate issues separately
from fixed-rate issues trade side by side and are purchased and have a different investor
base by the same investors
- "Unusual" features are common
- Many bonds have principal collateral and
rolling interest guarantees
Traditional yield to maturity ( YTM ) and spread over Treasuries
(SOT) are poor measures for the Brady market
All cash flows are discounted at the same
rate, regardless of any collateral
| Therefore...
For collateralized debt, this rate represents the return on blended
U.S./sovereign risk
For uncollateralized debt, this rate represents the return on pure
sovereign risk
| As a result...
Comparisons between collateralized and uncollateralized bonds or among
bonds with different amounts of collateral are distorted
Stripped yield and sovereign spread are better measures because
they account for collateral
Collateralized cash flows are discounted at
lower U.S. rates
Uncollateralized cash flows are discounted at higher sovereign rates
| Therefore...
Stripped yield and sovereign spread represent the return on pure sovereign
risk for both collateralized and uncollateralized bonds
| As a result...
Comparisons among bonds are not distorted by collateral differences
Traditional YTM and SOT misleadingly suggest that returns are
much better on uncollateralized bonds,
10/31/95 |
Argentina |
Brazil |
Venezuela |
| Bond |
FRBs |
Pars |
EIs |
Pars |
Pars |
DCBs |
| Collateral |
Yes |
No |
Yes |
No |
Yes |
No |
| Yield to maturity |
12.58% |
18.42% |
12.05% |
14.84% |
13.58% |
22.52% |
| Spd over
Treasuries |
630 bps |
1,255 bps |
576 bps |
893 bps |
734 bps |
1,663 bps |
while
stripped yield and sovereign spread suggest collateralized bonds offer better returns on
sovereign risk
10/31/95 |
Argentina |
Brazil |
Venezuela |
| Bond |
FRBs |
Pars |
EIs |
Pars |
Pars |
DCBs |
| Collateral |
Yes |
No |
Yes |
No |
Yes |
No |
| Yield to maturity |
12.58% |
18.42% |
12.05% |
14.84% |
13.58% |
22.52% |
| Spd over
Treasuries |
630 bps |
1,255 bps |
576 bps |
893 bps |
734 bps |
1,663 bps |
| Stripped
yield |
20.99% |
18.42% |
18.83% |
14.84% |
26.02% |
22.52% |
| Sovereign
spread |
1,499 bps |
1,254 bps |
1,279 bps |
892 bps |
2,008 bps |
1,665 bps |
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