Bonds refer to debt instruments bearing interest on maturity.
In simple terms, organizations may borrow funds by issuing debt securities named bonds, having a fixed maturity period (more than one year) and pay a specified rate of interest (coupon rate) on the principal amount to the holders.
Bonds have a maturity period of more than one year which differentiates it from other debt securities like commercial papers, treasury bills and other money market instruments.
More technically, bonds are negotiable certificates that represent the indebtedness of the issuer to the holder. The negotiable element refers to the fact that the ownership of a bond can be transferred from one party to another in the secondary market.
Terminology
Notes :
COUPON - Generally companies provide fixed rate of interest but FRNs are exception where rate of interest fluctuates. Another exception, zero-coupon bonds, do not pay any interest throughout their life. Instead, they provide a return to investors by being sold at a discount to the redemption (par) value. At maturity, the holder receives the full redemption amount. We will see them again below.
PRICE - The price of a bond is dependent upon a number of factors, including
Depending on the market, bond prices can be quoted ‘clean’ or ‘dirty’.
The clean or flat price of a bond is its price excluding accrued interest (the amount of interest due since the last coupon payment date). The seller, however, expects to receive the accrued interest on the bond, that is, the coupon amount that the seller has ‘earned’ by holding the bond since the last coupon payment date. The buyer must pay this accrued interest to the seller. Therefore, the dirty or full price (which includes the accrued interest) is the price paid by the buyer to the seller of a bond.
YIELD - The simplest measure of yield is current yield.
Current yield = Annual coupon / price
When bond is purchased at par, current yield = interest but when market value changes, so does the yield.
Yield is inversely proportional to price.
Better parameter for yield calculation is yield to maturity (YTM), which takes into account :
In simple terms, organizations may borrow funds by issuing debt securities named bonds, having a fixed maturity period (more than one year) and pay a specified rate of interest (coupon rate) on the principal amount to the holders.
Bonds have a maturity period of more than one year which differentiates it from other debt securities like commercial papers, treasury bills and other money market instruments.
More technically, bonds are negotiable certificates that represent the indebtedness of the issuer to the holder. The negotiable element refers to the fact that the ownership of a bond can be transferred from one party to another in the secondary market.
Terminology
Used in Bond Market | Meaning in General Terms |
| Bonds | Loans (in the form of a security) |
| Issuer of Bonds | Borrower |
| Bond Holder | Lender |
| Principal Amount | Amount at which issuer pays interest and which is repaid on the maturity date |
| Issue Price | Price at which bonds are offered to investors |
| Maturity Date | Length of time (More than one year) |
| Coupon | Rate of interest paid by the issuer on the par/face value of the bond |
| Coupon Date | The date on which interest is paid to investorstd-txt |
| Credit quality | Every one wishes to be confident that their money will be repaid. |
| Maturity | Maturity of bond can vary from one year to 1000 years, although most maturity period vary from 5 to 10 years. |
| Yield | It is the rate of return received from investing in bond and depends on the price paid for the bond and the coupon(interest) payment. |
Notes :
COUPON - Generally companies provide fixed rate of interest but FRNs are exception where rate of interest fluctuates. Another exception, zero-coupon bonds, do not pay any interest throughout their life. Instead, they provide a return to investors by being sold at a discount to the redemption (par) value. At maturity, the holder receives the full redemption amount. We will see them again below.
PRICE - The price of a bond is dependent upon a number of factors, including
- market interest rates,
- credit quality,
- maturity, and
- supply and demand.
Depending on the market, bond prices can be quoted ‘clean’ or ‘dirty’.
The clean or flat price of a bond is its price excluding accrued interest (the amount of interest due since the last coupon payment date). The seller, however, expects to receive the accrued interest on the bond, that is, the coupon amount that the seller has ‘earned’ by holding the bond since the last coupon payment date. The buyer must pay this accrued interest to the seller. Therefore, the dirty or full price (which includes the accrued interest) is the price paid by the buyer to the seller of a bond.
YIELD - The simplest measure of yield is current yield.
Current yield = Annual coupon / price
When bond is purchased at par, current yield = interest but when market value changes, so does the yield.
Yield is inversely proportional to price.
Better parameter for yield calculation is yield to maturity (YTM), which takes into account :
- The coupon payment on the bond on the way to maturity
- The time value of money
- Any capital gain or loss that will be realized by holding the bond until maturity
No comments:
Post a Comment