A few posts back we looked at Holding Period Return On Option-Free Fixed Income Securities. I thought we could take that one step further, and show horizon analysis for a bond swap. In order to help explain the calculator, I have divided the analysis into three sections and placed a rounded triangle around each one. The blue triangle is the present value or initial inputs. The example shows a swap from a U.S. Treasury (actual/365 day count) into a U.S. government agency (30/360 day count). The two dark yellow cells are drop down boxes with a choice of security types. As is true with all of my workbooks, light yellow cells are input cells.
After entering settlement date, enter the amount of par value you will sell, the maturity date, coupon, frequency of payments, and the yield to maturity the bonds will be sold at. For the bonds to be purchased, you have three options for par value. You can reinvest all the proceeds from the sold bonds ($/$), buy the same par value as sold (Par/Par), or enter a different amount altogether (Other). Note that in any case, the bonds will be rounded down to the nearest $1,000 in par value automatically. Continue on entering the description of the purchased bonds. Note that this example swap will increase the yield to maturity by 30 basis points. After prices and accrued interest is automatically calculated, the row called “Takeout/(Payup)” will be either the excess funds taken out of the swap if positive, or the additional funds needed to make the amount of proceeds equal to the amount invested in the new bonds (negative). Also note that the price calculated, given the yield to maturity, is rounded to three places which is the current convention.
At some point in the future, the swap will either be unwound, or marked to market. It is referred to as the horizon date. This is where the orange triangle comes in. After the horizon date is entered, you need the reinvestment assumption during the duration of this swap and the yields to maturity, at the horizon date, for the two bonds.
Then you get a recap of the swap that includes for the components of the swap. If you are familiar with the bond market, I think the recap is self explanatory. If not leave a comment.