Week2 BondMarket
WhatareBonds
A fixed income securitythatis issued with a borrowingarrangement
usuallyobligatingthe issuerto makeperiodicpayments of interestto the
bondholder investor overthelife ofthebond
Government and firmsneed
moneyto run and bankstypicallydo nothave
enoughmoney to support thedemand
Theyraisemoney byissuingbondswhich is nothingmorethan a loan which
investors bondholders arethe lenders
issuer must
paythe investorsomethingfortheprivilegeofusingtheirmoney
Interestpayments or coupons plustheprinciplevalue parvalue ofthebond
or if no coupons are paid needto purchase at a lowerpricethanthe principle value
of bond parvalue i e zerocouponbond
Someterminologies Bondcharacteristics
Facevalue parvalue or principlevalue
Thepayment made tobondholderatmaturityofthebond
Maturity
Howlongthebond lives it is the date ofthefacevalue is paid tothe investorsand
theissuerendshisobligations
coupons
Theinterest orcoupon paymentspaidtothe bondholders commonlyannuallyor
semi annually
couponis the periodicinterestpayment
Couponrate
Annualinterest ratewhichisdefinedas interestpaymentdivided byfacevalue
, Cashflow schedule ofatypical Bond
i
a
ie ii iiiiiii iiiit iiiii
iii
iiiiii iiiiiiiiiiiii.it
iiiiiit
Yieldtomaturity
YTM isthe total return anticipated of a bondassuming that it will be held to
maturitywith all coupon payment made as scheduledand reinvestedat the
samerate
Also known as book yield or redemption yield
canalso be viewed as internal rateofreturn IRR of an investment in a bond
Iftheinvestorholdsthe bonduntilmaturity
It is thediscountrate thatequatethesumof alldiscountedfuturecashflow coupon
principle of abond with its market price fairvalues IRR
Thuspresentvalueof bondscouponspaymentsandprincipal is accounted for
Whyis YTMimportant
It helpsdeterminewhether a bondinvestmentis profitable helpcomparebetween
bondstoo
Bondinvestors usuallyobservebondprices couponrates and maturityand a required
returntheyare looking for
They cancomparebetweenYTMandrequiredratesofreturn
IfYTM Their required rate ofreturn this bond appearsto be an attractivebuy
It isonlya snapshot of totalexpectedreturn of bonditheldmaturity
Theactualrealised returnof theinvestorditterand woulddependonthe supply
supplyforthebondsin the secondarymarket interestratemovements
WhatareBonds
A fixed income securitythatis issued with a borrowingarrangement
usuallyobligatingthe issuerto makeperiodicpayments of interestto the
bondholder investor overthelife ofthebond
Government and firmsneed
moneyto run and bankstypicallydo nothave
enoughmoney to support thedemand
Theyraisemoney byissuingbondswhich is nothingmorethan a loan which
investors bondholders arethe lenders
issuer must
paythe investorsomethingfortheprivilegeofusingtheirmoney
Interestpayments or coupons plustheprinciplevalue parvalue ofthebond
or if no coupons are paid needto purchase at a lowerpricethanthe principle value
of bond parvalue i e zerocouponbond
Someterminologies Bondcharacteristics
Facevalue parvalue or principlevalue
Thepayment made tobondholderatmaturityofthebond
Maturity
Howlongthebond lives it is the date ofthefacevalue is paid tothe investorsand
theissuerendshisobligations
coupons
Theinterest orcoupon paymentspaidtothe bondholders commonlyannuallyor
semi annually
couponis the periodicinterestpayment
Couponrate
Annualinterest ratewhichisdefinedas interestpaymentdivided byfacevalue
, Cashflow schedule ofatypical Bond
i
a
ie ii iiiiiii iiiit iiiii
iii
iiiiii iiiiiiiiiiiii.it
iiiiiit
Yieldtomaturity
YTM isthe total return anticipated of a bondassuming that it will be held to
maturitywith all coupon payment made as scheduledand reinvestedat the
samerate
Also known as book yield or redemption yield
canalso be viewed as internal rateofreturn IRR of an investment in a bond
Iftheinvestorholdsthe bonduntilmaturity
It is thediscountrate thatequatethesumof alldiscountedfuturecashflow coupon
principle of abond with its market price fairvalues IRR
Thuspresentvalueof bondscouponspaymentsandprincipal is accounted for
Whyis YTMimportant
It helpsdeterminewhether a bondinvestmentis profitable helpcomparebetween
bondstoo
Bondinvestors usuallyobservebondprices couponrates and maturityand a required
returntheyare looking for
They cancomparebetweenYTMandrequiredratesofreturn
IfYTM Their required rate ofreturn this bond appearsto be an attractivebuy
It isonlya snapshot of totalexpectedreturn of bonditheldmaturity
Theactualrealised returnof theinvestorditterand woulddependonthe supply
supplyforthebondsin the secondarymarket interestratemovements
