Fixed Income Securities, 4th Edition

CHAPTER 3Returns, Yields, Spreads, and P&L Attribution

Chapter 2 showed how swap or par rates, spot rates, and forward rates are used to describe the interest rates that can be earned in various markets, like the Treasury bond market or the interest rate swap market. While these rates are derived from the prices of individual financial instruments, they are intended to describe the time value of money in a market as a whole. This chapter, by contrast, focuses on rates that are specific to individual bonds and then uses both market‐wide and security‐specific rates for P&L (profit and loss) attribution.

The first section of the chapter defines the realized return on a bond over a given horizon. Ex‐post bond returns have to account for interim coupon payments and the reinvestment of those payments and are often computed on both a gross basis and net of financing, but are otherwise calculated like the returns on any other asset.

The next sections present yield to maturity. Bonds are often quoted and traded in terms of yield rather than price; yields are widely thought of as indicative of ex‐post returns; and differences in bond yields are commonly regarded as indicative of differences in value. The discussion reveals, however, that yields can be misleading with respect to both ex‐post returns and relative values.

The chapter continues with bond spreads. Because there are so many related but distinct fixed income products, spreads are used to quote, trade, and value one instrument ...