# Investigating Bond Mispricings: US Gov't Bonds Maturing 5/31/2012

• the4thamigo_uk
In summary, when comparing two US government bonds maturing on 31/5/2012, it is important to consider the difference in the final payments, which in this case is $2. However, the difference in price between the two bonds is only$0.75, which can be attributed to two reasons. First, the quoted bond prices do not include accrued interest, which would add an additional amount to the price. Second, it is not uncommon for Treasuries of similar maturities with different coupons to trade at small spreads. By taking into account these factors, the true difference in price between the two bonds is closer to $2. In addition, when buying the higher coupon bond, one would have to pay an the4thamigo_uk Ive been looking at quotes for two US government bonds maturing on 31/5/2012. I am trying to understand why they differ so much? Maturity Coupon Bid Asked Chg Asked Yield 5/31/2012 0.750 100.1250 100.1328 0.0078 0.045 5/31/2012 4.750 100.8750 100.8828 -0.0078 0.066 Source : http://online.wsj.com/mdc/public/page/2_3020-treasury.html (select historical data and choose Thursday, March 22, 2012) As I understand both these bonds have only one coupon remaining (i.e. the last one payable at maturity). The difference in the final payments between the two bonds is therefore: 4.75/2 - /75/2 =$2.

The discount rate for the payment of the principal and final coupon is the same for both bonds. I can approximate this by looking at the rates for the zero coupon treasury bill

5/31/2012 0.065 0.060 -0.0100 0.0610

Source : http://online.wsj.com/mdc/public/page/2_3020-treasury.html
(select historical data and choose Thursday, March 22, 2012, then click Goto Bills)

The yield of the zero bond is very low (0.061% annualized) and we are fairly close to maturity, so the discount factor is very close to 1. The difference in price of the two bonds, should therefore be roughly the difference in the value of the final coupon. i.e. $2. But the difference in price is only$0.75.

As I understand it market convention is to quote prices as 'clean'. I am assuming WSJs quotes are clean. If so, what explains the large discrepancy?

two issues:

1) the quoted bond prices do not include accrued interest - if you bought the higher coupon bond on April 1 you would pay an additional amount equal to 5/6 of the semiannual payment

2) its not uncommon for Treasuries of similar maturities with different coupons to trade at small spreads , in this case 2.1 basis points

Ok, so the quotes are clean...

31st may is maturity, this is about 10 weeks ~ 70 days, so I add 70/180 of the coupon onto the clean price of the bonds i.e. taking the bid price we get dirty/cash prices of

100.1250 + .75/2 * (180-70)/180 = 100.3542
100.8750 + 4.75/2 * (180-70)/180 = 102.3264

difference = 1.9722 (which is more like what I expected)

ahh... right I got it... so if i bought the bond now I would forfeit most of the coupon

## 1. What are bond mispricings?

Bond mispricings refer to discrepancies in the price of a bond compared to its true market value. This can occur due to various factors such as market volatility, supply and demand imbalances, and human error.

## 2. Why is it important to investigate bond mispricings?

Investigating bond mispricings is important because it can help identify potential investment opportunities. If a bond is priced lower than its true value, it may be a good time to buy. On the other hand, if a bond is overpriced, it may be a good time to sell.

## 3. How are bond mispricings detected?

Bond mispricings can be detected through various methods such as analyzing historical data, comparing a bond's price to its peers, and using financial models to calculate its fair value. Additionally, market participants may also report any discrepancies they notice.

## 4. What are the potential risks of investing in mispriced bonds?

Investing in mispriced bonds carries some risks, as the market may eventually correct the price and the investor may lose money. Additionally, if the mispricing was due to human error or fraud, there may be legal implications for the investor.

## 5. How can bond mispricings be prevented?

Bond mispricings can be prevented through proper risk management and due diligence. Investors should thoroughly research and analyze a bond before investing in it. Additionally, market regulators and authorities play a crucial role in detecting and preventing bond mispricings through monitoring and enforcing fair trading practices.