Topic 2 - Bond Prices Flashcards
Bond definition
A security sold by governments or corporations to raise money from investors, in exchange for promised future payments.
2 TYPES: coupon or zero coupon
Equity/ Stock market
A place where people buy and sell shares of companies.
Yield to Maturity (YTM)
This is the discount rate that makes the current market price of a bond = PV face value + PV coupons
IRR
The discount rate that NPV = 0 at. it Indicates the rate of growth of of an investment
Maturity date
the date of the final repayment
term
the time remaining until the date of the final repayment
face value
the value of the bond on its maturity date
coupon rate
the interest rate paid on the bonds face value
zero coupon bond
a bond that doesn’t make coupon payments. it is issued at a discount to the face value.
coupon bond
a bond that makes regular interest payments called coupons throughout the life of the bond. the coupons are a fixed percentage of the face value
trading at discount, par, premium meaning
discount: price < face value
par: price = face value
premium: price > face value
who benefits from a bond trading at a premium?
Current bondholders. They can sell it while its trading at a premium and make a profit from it. This happens because the bond would’ve been issued when interest rates were higher, now they’ve fallen and you’re bond is worth more because it still pays interest at the original rate - higher than the current market offer.
corporate bonds
there is risk of default in corporate bonds. the price of a corporate bond is less than a government issued one because its riskier.
Zero coupon bond price formula
Price = FV/ (1+ r)^N
Bond Rating
AAA is seen as a fairly stable bond. CCC is seen as risky, and unstable.
Junk Bonds
Junk bonds are high risk, high reward bonds. Since they are riskier, they have to offer higher interest rates to attract investors.
Investment grade bonds
Low risk, low reward bonds that are issued by companies, governments or other entities that have high credit ratings, indicating that they are low risk for default.
What is credit/ default risk
this is the possibility that a borrower fails to pay back the bond payments. credit risk measures how likely this is to happen to help investors make informed decisions.
