FİNANSAL PİYASALAR VE KURUMLAR - Deneme Sınavı - 9

Bond is a long-term financial instrument issued by companies or governments, which provides interest and principal payments to the holders on specific dates.

The most common type of bonds traded in the markets is straight mcoupon bonds, which provide the holder to receive  periodic interest payments and principal on specified date.

Government (treasury) bonds which are issued to satisfy long-term financing needs.

The main factor that determines the coupon rate of the corporate bonds is creditworthiness of the issuer.

The value of a financial asset is the present value of future cash flows expected from the asset. For this reason, determination of price of an asset requires an estimation of expected cash flows and an appropriate discount factor, which refers to the required rate of return or required yield.

The coupon rate of floating-rate bonds  change depending on a reference rate.

Duration is a first order interest rate risk measure, which uses first-order derivatives. However, convexity uses second-order derivatives and represents a second order
interest rate risk.

There are some elements that determine the characteristics of the bonds. These are (Williams,
2011, p. 176);
• Par value,
• Form of the bond (Bearer or registered)
• Payment method (Coupon or discount)
• Coupon payment frequency (annually, semiannually, quarterly or monthly)
• Maturity,
• Call feature if it is callable,
• Sinking fund if it is a sinking fund bond,
• Creditworthiness of the issuer.

One of the most widely used benchmarks for floating rate is the LIBOR (London Interbank Offered Rate), which is the borrowing rate in the London Interbank Market. Another reference rate is the Prime Rate, which is the interest rate that banks charge their most creditworthy customers.

Dirty price of a bond is the price that includes 38the accrued interest at the settlement date.

Two factors fundamentally determine the call risk. First of these factors is the length of the call provision. The call risk increases as the length of call provision increases. The second factor is the coupon rate of the bond. While other things are the same, call risk of a bond with a lower coupon rate is lower than call risk of a bond with a higher coupon rate 41(Robinson and Wrightsman, 1980, p. 157).

Investors may prefer bonds over stocks in order to diversify and minimize risks as bonds are considered less risky investment tools. Bonds provide steady income since they are decidedly more predictable when compared to stocks and may also offer coupon payments. However, dividend payments cannot be a reason to choose bonds over stocks, since dividend payments are a characteristic of stocks only and bond-owners do not receive dividend payments. (Bonds are debt instruments and therefore do not give ownership rights such as voting rights, asset rights, and dividend rights.)

The main factor that determines the coupon rate of the corporate bonds is creditworthiness of the issuer.

V_B = P / (1+i)ⁿ
V_B  = $1000/(1,09)³ = $772.18

Besides the default risk, credit rating agencies provide information about the downgrade risk of the bonds.

While duration or Macaulay duration reflects the sensitivity of a bond to the interest rate changes, modified duration evaluates the effects of yield changes on the price of the bond.