Part 1 - Bonds and bond market overview
14 October 2025 17:16
Bonds
Bonds (also commonly called fixed income securities) are debt investments in which an investor
loans money to an entity (corporate, governmental or other) that borrows the funds for a defined
period of time (or forever) at a fixed interest rate
- For the issuer, it is a way of raising capital
Bond features
- Type of issuer
○ National, regional, local government
○ Governmental agencies, charities
○ Corporations
○ Others
- Term to maturity
○ For redeemable bonds, the term to maturity refers to the point when the issuer will
redeem the bond by paying the principal
○ There may be provisions in the indenture (contract under which a bond is issued) that
allow either the issuer or bondholder to alter a bond's term to maturity
○ Some bonds are irredeemable and thus have no maturity date
- Principal, coupon rate, coupons
○ Principal: amount the issuer agrees to repay to the bondholder at the maturity data aka
the nominal face-value
○ Coupon rate: interest rate the issuer agrees to pay each year applied to the principal
○ Coupon: periodic interest payment
○ Zero-coupon bond: no interest paid via coupons; return is provided solely by capital gain
○ Floating-rate bond: issues where the coupon rate resets on a specified date(s) based on
a specific formula
- Amortization feature
○ The principal repayment of a bond can call for either
Total repayment to be paid at maturity
Or principal repaid over the life of the bond
○ In the latter case, the schedule of principal repayments is the amortization schedule
○ For amortizing securities, a measure called the ‘weighted average life’ (or, simply,
‘average life’) can be computed
- Embedded options
○ Some bond issue indentures include provisions that give the bondholder and/or the
issuer an option in specified circumstances and with specified conditions
Call provision - grants the issuer the right to retire (buy back/redeem) the debt,
fully or partially, before the scheduled maturity date
Put provision - gives the bondholder the right to sell the issue fully or partially
back to the issuer before the scheduled maturity date
Convertible bond - provides the bondholder the right to exchange the bond for
other securities of the issuer
Exchangeable bond - allows the bondholder to exchange the issue securities of
another issuer
Risk associated with bond investing
Interest-rate risk
- AKA price risk/volatility - the price of a bond in the market is almost inevitably different to its
face value
Prices move up and down very quickly and can be impacted by a variety of factors
Finance Page 1
, ○ Prices move up and down very quickly and can be impacted by a variety of factors
including economic and world events
- The amount of income received on a bond is fixed so if we have a fixed income stream but if
the price/value of a bond changes, the return we actually get changes
○ If prices go up, we pay more for the same stream of coupons -> lower yield and vice
versa
- Impacted by: pure-time preference, inflation premium (if it is a nominal rate) and risk
premium
○ Pure-time preference and inflation premium are both strongly linked to base rates in an
economy
Factors affecting base rates -> main MPC focus is on inflation and economic
activity/growth but these are impacted by a plethora of things which can impact
base rates
○ Risk premium is determinant of the level of risk taken by investing in a certain
instrument (may vary from one economy/industry/company to another
Reinvestment risk
- Cash received through coupon --> reinvestment opportunities may not be the same as those
when the investor originally invested in the bond so there is increased uncertainty in
reinvesting the cash value
- Also the case given a scenario with a call provision which would repay the investor the whole
value of the principal as the issuer will likely exercise the call option if they can issue different
securities with more favourable terms to others in the market
Credit risk
- Issuer may in some way not fulfil the bond contract i.e. not paying the coupon/principal
repayment at the amount contracted on the date contracted (bond default)
Inflation risk
- Fixed income coming out of the bond
○ If the money being repaid doesn't keep up with inflation, you will not be adequately
compensated for inflation premium
ER risk
- Investing in a bond in a currency other than your own 'life currency' which could be for
diversification reasons
○ Exposes you to currency exchange risk
Liquidity risk
- If a company's bonds become thinly traded for example it may make it harder to liquify your
asset
Markets for bonds
Primary market
- Where bonds are first issued and capital is raised from bond investors
○ Bonds don’t have to be issued at the principal/ nominal value
Secondary market
- Where bonds that have been issued previously are traded
- Secondary trading occurs on both recognised exchanges and over-the-counter (OTC)
Finance Page 2
14 October 2025 17:16
Bonds
Bonds (also commonly called fixed income securities) are debt investments in which an investor
loans money to an entity (corporate, governmental or other) that borrows the funds for a defined
period of time (or forever) at a fixed interest rate
- For the issuer, it is a way of raising capital
Bond features
- Type of issuer
○ National, regional, local government
○ Governmental agencies, charities
○ Corporations
○ Others
- Term to maturity
○ For redeemable bonds, the term to maturity refers to the point when the issuer will
redeem the bond by paying the principal
○ There may be provisions in the indenture (contract under which a bond is issued) that
allow either the issuer or bondholder to alter a bond's term to maturity
○ Some bonds are irredeemable and thus have no maturity date
- Principal, coupon rate, coupons
○ Principal: amount the issuer agrees to repay to the bondholder at the maturity data aka
the nominal face-value
○ Coupon rate: interest rate the issuer agrees to pay each year applied to the principal
○ Coupon: periodic interest payment
○ Zero-coupon bond: no interest paid via coupons; return is provided solely by capital gain
○ Floating-rate bond: issues where the coupon rate resets on a specified date(s) based on
a specific formula
- Amortization feature
○ The principal repayment of a bond can call for either
Total repayment to be paid at maturity
Or principal repaid over the life of the bond
○ In the latter case, the schedule of principal repayments is the amortization schedule
○ For amortizing securities, a measure called the ‘weighted average life’ (or, simply,
‘average life’) can be computed
- Embedded options
○ Some bond issue indentures include provisions that give the bondholder and/or the
issuer an option in specified circumstances and with specified conditions
Call provision - grants the issuer the right to retire (buy back/redeem) the debt,
fully or partially, before the scheduled maturity date
Put provision - gives the bondholder the right to sell the issue fully or partially
back to the issuer before the scheduled maturity date
Convertible bond - provides the bondholder the right to exchange the bond for
other securities of the issuer
Exchangeable bond - allows the bondholder to exchange the issue securities of
another issuer
Risk associated with bond investing
Interest-rate risk
- AKA price risk/volatility - the price of a bond in the market is almost inevitably different to its
face value
Prices move up and down very quickly and can be impacted by a variety of factors
Finance Page 1
, ○ Prices move up and down very quickly and can be impacted by a variety of factors
including economic and world events
- The amount of income received on a bond is fixed so if we have a fixed income stream but if
the price/value of a bond changes, the return we actually get changes
○ If prices go up, we pay more for the same stream of coupons -> lower yield and vice
versa
- Impacted by: pure-time preference, inflation premium (if it is a nominal rate) and risk
premium
○ Pure-time preference and inflation premium are both strongly linked to base rates in an
economy
Factors affecting base rates -> main MPC focus is on inflation and economic
activity/growth but these are impacted by a plethora of things which can impact
base rates
○ Risk premium is determinant of the level of risk taken by investing in a certain
instrument (may vary from one economy/industry/company to another
Reinvestment risk
- Cash received through coupon --> reinvestment opportunities may not be the same as those
when the investor originally invested in the bond so there is increased uncertainty in
reinvesting the cash value
- Also the case given a scenario with a call provision which would repay the investor the whole
value of the principal as the issuer will likely exercise the call option if they can issue different
securities with more favourable terms to others in the market
Credit risk
- Issuer may in some way not fulfil the bond contract i.e. not paying the coupon/principal
repayment at the amount contracted on the date contracted (bond default)
Inflation risk
- Fixed income coming out of the bond
○ If the money being repaid doesn't keep up with inflation, you will not be adequately
compensated for inflation premium
ER risk
- Investing in a bond in a currency other than your own 'life currency' which could be for
diversification reasons
○ Exposes you to currency exchange risk
Liquidity risk
- If a company's bonds become thinly traded for example it may make it harder to liquify your
asset
Markets for bonds
Primary market
- Where bonds are first issued and capital is raised from bond investors
○ Bonds don’t have to be issued at the principal/ nominal value
Secondary market
- Where bonds that have been issued previously are traded
- Secondary trading occurs on both recognised exchanges and over-the-counter (OTC)
Finance Page 2
