The Bond Market

Question 1

Who issues and purchases bonds

Answer 1

Issued by:
Governments
Local Governments
Companies

Purchased by:
Individuals
Businesses
Governments
Foreign Investors
Financial Institutions

Question 2

What are Bonds

Answer 2

Bonds are negotiable instruments which pay (general) a fixed rate of interest, known as the coupon rate

The interest is paid at regular intervals and is known as a ‘coupon’

The ‘par’ (or redemption or maturity) value of the bond is fixed at its time of issue

Most bonds have a redemption date, fixed at the time of issue Most bonds

Question 3

Bond Maturity

Answer 3

Initial Maturity: The length of time from the date issued to the date of maturity/ redemption

Residual Maturity: Is the length of the time from sale/purchase to date of maturity, this declines over time

< 5 years = shorts
5 -15 years = mediums
> 15 years = longs

Question 4

UK Bonds (Gilts)

Answer 4

The par value in the united kingdom is £100 and so the coupon rate can be calculated as:

Coupon / Par = Par Value

E.G. Treasury %3 2025 pays £3 per year until redemption date in 2025

Question 5

Standard Bonds

Answer 5

Bullet Bonds: set maturity (can’t be paid off early)

Term Bonds: set maturity (can be paid off early)

Zero Coupon Bonds: and are sold at a discount like bills

Question 6

Bonds that Reduce Risk

Answer 6

By effectively shortening their duration:

Serial Bonds - Pay off some principal amount at set times before maturity

Sinking Fund Bonds - issuer pays off into an account held by the trustee

Question 7

Bonds that Offer Security

Answer 7

Mortgage Bonds - a lien against property
Collateral Bonds - Financial Assets other than property
Debenture Bonds- right to assets not currently a form of security on other debts

Question 8

Bonds with Additional Flexibility

Answer 8

Convertible Bonds - option or the right to convert their bond into predetermined number of shares

Floating Rate Bonds - maturity value and coupons maybe index linked

Putable Bonds - Gives the owner the right to sell back the bond at specific dates (repurchase price is set at time of issue)

Question 9

Bond Pricing

Answer 9

The most common way of calculating bond price is to use the present value method - two future cash flows

Clean Bond Price - Price excluding any accrued interest
Dirty Bond Price - clean price + any accrued interest the holder would receive
Bond Price will always converge towards par value as it gets closer to maturity
Bond price will always have an inverse relationship with interest rates

Question 10

Factors affecting bond prices

Answer 10

The Cash flow (or coupon)
The face value of the bond at maturity
The number of cash flows
The discount rate