2. Bond Market
• The bond market is often referred to as the debt market, fixed-
income market, or credit market. It is the collective name given
to all trades and issues of debt securities.
• Governments issue bonds to raise capital to pay debts or fund
infrastructural improvements. Publicly traded companies issue
bonds to finance business expansion projects or maintain
ongoing operations.
3. Bond Valuation
• Bond valuation is a technique for determining the theoretical fair
value of a particular bond.
• Bond valuation includes calculating the present value of a
bond's future interest payments, also known as its cash flow,
and the bond's value upon maturity, also known as its face
value or par value.
• Because a bond's par value and interest payments are fixed, an
investor uses bond valuation to determine what rate of return is
required for a bond investment to be worthwhile.
4. Characteristic of Bond
• Bond issuer: This is the entity or company seeking to borrow money
from investors and is the entity or company that should repay the
money borrowed.
• Maturity date: This is the date at which the bond will be redeemed
i.e. when the outstanding principal amount is repaid back to the
investor. Maturities of bonds can range from overnight to 30 years or
more.
• Coupon: This is the nominal rate of interest that an issuer agrees to
pay to the bondholder each year until the maturity date. It is usually
expressed as a percentage (%) of the face value of a bond and is
almost always given as a per annum rate.
5. • Face Value (FV): This is also known as the notional or principal amount,
which is the amount that will be repaid to the bondholder upon maturity.
This is given as a currency amount, for example, $5 million.
• Bond Price: The current market price of a bond is expressed as a
percentage of face value. Bonds are tradable in the secondary market and
the prices at which bonds can be bought and sold at are recorded in
percentage terms.
• Bond Yield: This refers to the returns an investor will derive by investing
in a bond. It is calculated by dividing the annual coupon on a bond by its
current market price.
Bond Yield = Annual Coupon Payment on a Bond / Bond Price
The annual coupon payment is computed by multiplying the face value of a
bond with its coupon rate (%). Bond prices and bond yields have an inverse
relationship. When the price of a bond goes up (down), the yield goes down
(up).
6. Bond Yield
• The Bond Yield is the rate of return expected to be received by
a bondholder from the date of original issuance until maturity.
9. Zero Coupon Bond
• A Zero Coupon Bond is priced at a discount to its face (par)
value with no periodic interest payments from the date of
issuance until maturity.
• A zero-coupon bond, also known as an accrual bond, is a
type of debt security that doesn’t pay interest during its tenure.
Instead, it’s issued at a deep discount and provides a profit at
maturity when it’s redeemed for its full face value. Let’s delve
into this financial instrument with an example:
11. Example of a Zero-Coupon Bond
• X wants to purchase a zero-coupon bond with the following
details:
• Face value: $1,000
• Maturity period: 5 years
• Interest rate: 5% compounded annually
• X will pay approximately $783.53 for the bond today
12. Zero Coupon Bond Price Calculation
Example
• Face Value (FV) = $1,000
• Number of Years to Maturity = 10 Years
• Compounding Frequency = 2 (Semi-Annual)
• Yield-to-Maturity (YTM) = 3.0%
What price are you willing to pay for the bond?
Present Value (PV) = $1,000 / (1 + 3.0% / 2) ^ (10 * 2)
PV = $742.47
• The price of the bond is $742.47.
13. Zero Coupon Bond Yield Calculation
Example (YTM)
• Face Value (FV) = $1,000
• Number of Years to Maturity = 10 Years
• Compounding Frequency = 2 (Semi-Annual)
• Price of Bond (PV) = $742.47
Semi-Annual Yield-to-Maturity (YTM) = ($1,000 / $742.47) ^ (1 /
10 * 2) – 1 = 1.5%
Annual Yield-to-Maturity (YTM) = 1.5% * 2 = 3.0%
16. Normal yield- Upward curve
• As yields increase over time, the points on the curve exhibit the
shape of an upward-sloping curve.
• Sample yields on the curve may include a two-year bond that
offers a yield of 1%, a five-year bond that offers a yield of 1.8%,
a 10-year bond that offers a yield of 2.5%, a 15-year bond offers
a yield of 3.0% and a 20-year bond that offers a yield of 3.5%.
• This curve indicates yields on longer-term bonds continue to
rise, responding to periods of economic expansion.
17. Inverted yield curve- slopes downward
• An inverted yield curve slopes downward, with short-term
interest rates exceeding long-term rates. Such a yield curve
corresponds to periods of economic recession, where investors
expect yields on longer-maturity bonds to trend lower in the
future.
• In an economic downturn, investors seeking safe investments
tend to purchase longer-dated bonds over short-dated bonds,
bidding up the price of longer bonds and driving down their
yield.
• Economic recession
18. Flat Yield Curve
• A flat yield curve reflects similar yields across all maturities,
implying an uncertain economic situation. A few intermediate
maturities may have slightly higher yields, which causes a slight
hump to appear along the flat curve. These humps are usually
for mid-term maturities, six months to two years.
• The curve shows little difference in yield to maturity among
shorter and longer-term bonds. A two-year bond may offer a
yield of 6%, a five-year bond of 6.1%, a 10-year bond of 6%,
and a 20-year bond of 6.05%. In times of high uncertainty,
investors demand similar yields across all maturities.
