Bonds (Financial Markets & Regulation) Flashcards
What are bonds?
An instrument that can be issued and sold to raise finance (IOUs)
They can be issued by firms (corporate bonds) that are needed to fund investment projects, and governments (UK Gilts) that are needed to raise finance deficits in fiscal years.
What form of capital are bonds?
Debt capital: they have to be repaid back over time with interest and the debtor does not get a stake in the business.
Bondholders recieve…
…periodic payments linked to the value of the bond until the bond matures.
What is the issue price?
The price at which the bond is issued at. Often differs from the current market value of the bond.
What is the issue date?
the date at which a bond is issued and sold to the market.
What is a coupon payment?
Periodic payment that the bondholder recieves during the time between when the bond is issued and when it matures.
What is the maturity date of a bond?
The final payment of a bond at which point the principal is due to be paid.
What is a bond yield?
The annual coupon payment expressed as a percentage of the market price of the bond (can be interpreted as the rate of interest earned by the bondholder over the lifetime of the bond).
How do bonds raise finance?
The creditor issues a bond to the debtor, with a fixed rate of interest (coupon). The bond provides finance for the debtor’s expenditure, however they have to repay the bond back to the creditor periodically before the agreed maturity date as well as the coupon on top. The creditor will then be better off than they were before they issued the bond due to the return from the coupon.
How do you calculate bond yields?
Bond yield = (annual coupon rate / current market price of the bond) x 100
What is the relationship between bond yields and the market price for bonds?
Inverse relationship.
- As the market price for the bond rises, the bond yield falls.
- As the market price for the bond falls, the bond yield rises.
How are bonds affected by interest rates?
There is an inverse relationship between interest rates and bond prices. Interest rates affect the realtive attractiveness of interest bearing assets.
- If Bond A has a annual coupon payment of 10%, but interest rises to 15% a year later, all new bonds issued will look more attractive to investors as they will generate a greater return due to them having a higher annual coupon payment.
- To look more attractive, Bond A will reduce it’s price to match this.
And vice versa if there is a cut in interest rates.
What are the 2 types of investor expectation?
Hawkish expectations = interest rate hike - sell bonds, supply of bonds increases - Price falls, Bond yields rise.
Dovish expectations = cut interest rates - buy bonds, supply of bonds fall - Price rises, Bond yields fall.
