Bond
loan from an investor to an issuer
- Receive semi-annual coupons
o Is typically a percentage of par
- At maturity, bond owner returns loan at whatever par value
- Can sell bond whenever, but would be at market price
What do you receive when bond is fully mature?
return whatever par value + the last semi annual coupon payment
Interest Rate Risk
describes how bond price and interest rates react
- “Inverted” relationship
- when interest rates go up, bond prices go down
Duration
the measure (in years) of how much a bond’s price is likely to change when interest rates move
Bonds with Longer Duration
- Long duration bond has more interest rate risk (longer duration, longer maturity)
- Low coupon has more interest rate risk (longer duration, lower coupon)
Coupon yield/nominal yield
same as coupon rate, does not change, determined when issued
Current yield
coupon yield divided by market price (annual interest/current market value)
Yield to Maturity (YTM):
overall return of bond if held to maturity (if its at a discount, YTM > coupon)
Bond Quotes
State the price of a bond as percentage of its par value (have quote be whatever price of bond * 1000
Callable bonds
agreed upon before. higher coupon for investor than if feature not included (this would allow the issuer to take a bond at a set price)
- Can get protection on this
Credit Risk
risk of default (issuer unable to give principal payments)
Bonds with more liquidity
good credit
Risks associated with Interest Rate Change
When interest rates go down: potential for call risk & reinvestment risk
- Interest rates go up: potential for interest rate risk
Accrued Interest
interest a bond holder has earned but has yet to receive (based on when you get your semi-annual coupon – get that percentage of coupon if you sell it (here new buyer would compensate original bond owner and pay coupon, but would receive entire coupon at end of cycle)
- This is taxed
- Bond that trades with no accrued interest: Trades flat (ex: a zero-coupon bond)
Accrue Cycle by Bond Type
- Corporate & Municipal bonds accrue using 30 day months & 360 day years
- Government bonds accrue using actual days and months
Par value of a corporate bond
$1000
A bond priced below par
Discount
Bond priced above par
Premium
Risk that a bond may be called prior to maturity
Call risk
