Week 5: bonds Flashcards
What is a Bond?
Debt instrument, issued by a borrower for a fixed period of time, paying interest known as a coupon which is fixed at issue date and is paid periodically until it is redeemed at maturity, at which time the principal amount is repaid
How can we classify bonds
In terms of the nature of the bond
- Can classify based on place of issue
- Can classify by issuer
What are the variety of forms bonds come in?
Straight, plain vanilla or bullet bonds
- Zero coupon bonds
- Floating-rate or variable-rate bonds
- Index-linked bonds
- Convertible bonds
What are the differing classifications of Bonds based on place of issue?
Domestic Bonds -Foreign Bonds -Eurobonds (Issued in a currency outside that country) e.g. Bond issued in US in GBP
What are the differing issuers of Bonds?
Central governments and government agencies
- State and local governments
- Companies
- Supranational institutions (eg. World Bank)
What are the 3 big credit rating agencies?
- Moodies
- Standard and Poor (S&P)
- Fitch
How does the credit rating agency scale work?
AA= Minimal Risk
All the way down to D which indicated a company/country defaulted
What the Current Types of Gilts?
Conventional gilts, for example: 1 1/2% Treasury Gilt 2047
Index-linked Gilts:
Coupon and Redemption increases with inflation
Gilt Strips:
breaking it down into its individual cash flows can be traded separately as zero coupon bonds
E.G. a three-year gilt will have seven individual cash flows: six (semi-annual) coupon payments and a principal repayment.
How do you calculate Perpetual Bonds?
PV = C/R
Where:
- PV: Present Value of bond
- C: The coupon rate x Nominal (par) value of the bond
- R: Discount Rate
How do you calculate the Conventional Bond?
PV =
PV(P) = C/R (1 - 1/(1+R)t)+ V/(1+R)t
Where V is the par value
Where t is to the power of
What are the historic type of Gilts?
- Undated gilts
- Double-dated conventional gilts
- Floating rate gilts
How do you calculate the interest yield?
Coupon/ Market Price
hat are the issues to calculating the Interest Yield?
Doesn’t take into consideration:
- Time value of money
- No way to see capital gain/loss
What is the Redemption Yield? (Also known as Yield to Maturity)
The discount rate such that the present value of all the cash inflows from the bond (interest plus principal) is equal to the bond’s current market price
How do you calculate the redemption yield?
YTM = (C+ F-P/N)/(F+P)/2
Where:
- C = Coupon Rate
- F = Face Value
- P = Current Price
- N = Number of Years
How do you calculate spot rates?
p = (c+V)/1+r1 P = market price V = par value c = coupon r1 = spot rate
What is a Zero Coupon Bond?
only have payment on maturity
- pure discount bonds
How do you calculate zero coupon bonds?
P0 = 100 / (1 + rt)^t
How do we calculate Forward Rates?
foward rate = (1+r_t+1)^t+1 / (1+rt)^t
What is the Interest Rate Hypothesis?
Expectations:
- Forward rate is the best market estimate of the future spot rate
Liquidity premium:
-Lenders prefer to lend short, whereas borrowers prefer to
Inflation Premium:
- inflation risk is the greatest concern to investors
- short term is easy, to do long term the need a premium
market segmentation:
-Demand and supply for bonds of different maturities will vary.
definition of a coupon
yment on a bond is the annual interest payment that the bondholder receives from the bond’s issue date until it matures.
redemption yield definition
yield of a stock calculated as a percentage of the redemption price with an adjustment made for any capital gain or loss which that price represents relative to the current price.
definition of a treasury bill
short-dated UK or US government security, yielding no interest but issued at a discount on its redemption price.
defintion of an index linked gilt
—pay interest that is linked to an underlying index, such as the Consumer Price Index (CPI).
definiton of a gilt
nominal bonds that promise to pay a fixed coupon rate at set time intervals, such as every six months. They represent the majority of government debt. When a conventional gilt matures, its holder receives the last coupon and the principal.
definition of interest yield
. the INTEREST paid on a BOND or LOAN STOCK etc., expressed as a percentage of the current market price of the bond or stock.
