Bond Markets
What does bond refer to?
Bond refers to fixed-income security and a type of debt instrument.
What are the elements that determine the characteristics of the bonds?
• 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.
How does an increase in maturity affect a bond?
As the maturity of a bond increases, the price volatility of the bond will increase due to the changes in market yields.
What does the return of a zero-coupon bondholder refer to?
The return of a zero-coupon bondholder is the difference between the discounted price and the par value, which will be paid at the maturity date.
Why are the coupon rates of government bonds lower than the coupon rates of the company bonds?
Coupon rates of government bonds are lower than the coupon rates of the company bonds, since the return of the bondholders are considered as risk-free return.
What is the importance of the creditworthiness of the issuer?
The creditworthiness of the issuer reflects the default risk of the bond. For this reason, the bond investors should evaluate the creditworthiness of the corporation in an investment process.
How do foreign bonds differ from Eurobonds?
While Eurobonds are denominated in a currency that is different from the currency of the country where the bond is issued, foreign bonds are denominated in the currency of the country where they are sold.
Why is the math of time value of money important when comparing investment alternatives?
To compare the investment alternatives, we must know the math of time value of money because the value of the alternatives must be on the same timeline in order to choose the best one.
What does the value of a financial asset refer to?
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.
What does it mean if the bond is sold at the price above or below the estimated value?
If the bond is sold at the price below the estimated value, then it means that the bond is overvalued and it can be purchased. If the bond is sold at the price above the estimated value, then it means that the bond is undervalued and the bondholder can sell the bond.
What is important in the valuation of the bonds that pay coupons semiannually?
While valuing the bonds that pay coupons semiannually, the annual coupons and discount rate must be revised according to the period.
What does dirty price of a bond refer to?
Dirty price of a bond is the price that includes the accrued interest at the settlement date.
How is the current yield of a bond calculated?
The current yield of a bond is calculated by dividing the coupon payment to the current price of the bond.
What does yield to maturity refer to?
Yield to maturity (YTM) of a bond is the internal rate of return of a bond.
How does an increase in the downgrade risk affect the price of the bond?
An increase in the downgrade risk results in a decrease in the price of the bond.
What is the correlation between the prices of fixed income securities and the interest
rate changes?
Typically, prices of fixed income securities move in the opposite direction of the interest rate changes. For example, the price of a bond increases when the interest rates decrease, and price of a bond decreases when the interest rates increase.
How does depreciation of the foreign currency affect the holders of foreign bonds?
If the foreign currency depreciates, the holders of foreign bonds will receive less amount of money in domestic currency when they convert the foreign currency that stems from the bond investment.
What does duration refer to?
Duration is a measure of interest rate sensitivity of bond and gives the weighted average time to receive the cash flows of the bond.
How does high coupon rate affect the duration of a bond?
Duration of a bond with higher coupon rate is shorter than the duration of a bond with lower coupon rate.
Which circumstances would make convexity a better measure than the duration?
If the interest rate changes are large, the magnitude of price changes will be different for increases and decreases. In this case, convexity is a better measure than the duration.
What does the rating of bonds indicate?
Bonds with high ratings are considered safer than the lower-rated bonds. If a bond has a very low rating, then investing in this bond is considered speculative.