Bond

© All Rights Reserved

2 visualizações

Bond

© All Rights Reserved

- Test Bank - Problems and Essays 2008
- 02-2 Market Risk Premium and Risk Free Rate Survey
- All About Bonds
- Fin 370 Genius
- ch 11
- Investment Outlook: Navigating through risky waters
- Managing Bond Portfolios Ch16 Activepassiv
- Primer for Investing in Bonds
- Exam_1
- Lecture 8 Notes
- US Internal Revenue Service: 2007p1212 sect i-iii
- Ch12 Solutions Upload
- 2017 GMI - Real Vision - Macro
- p4 article
- Advanced Maths
- Exam1Sp11
- Sav Pdp 0036
- US Treasury: ps-1991-q1
- Stocks and Bonds
- Blackrock Sovereign Risk Update.pdf

Você está na página 1de 11

Bond

A bond is a type of investment that represents a loan between a borrower and a lender.

Think of it as similar to getting a personal loan from a bank except in this case you are the

lender (known as the investor or creditor) and the borrower is generally a government or

corporation (known as the issuer).

With bonds, the issuer promises to make regular interest payments to the investor at a

specified rate (the coupon rate) on the amount it has borrowed (the face amount) until a

specified date (the maturity date). Once the bond matures, the interest payments stop and the

issuer is required to repay the face amount of the principal to the investor.Because the interest

payments are made generally at set periods of time and are fairly predictable, bonds are often

called fixed-income securities.

Different between Bond and Stock

Bonds are considered debt investments. On the other hand, a stock purchase is

considered an equity investment because the investor (also known as the stockholder)

becomes a part owner of the corporation.

The issuers of stock or equity are typically companies; issuers of debt can be either

companies or governments. While bonds generally dont provide an opportunity to share in

the profits of the corporation, the stockholder is entitled to receive a portion of the profits and

may also be given voting rights. Bondholders earn interest while stockholders typically

receive dividends. Both may experience capital gains or capital losses if the price at which

they sell their holdings is, respectively, higher or lower than the price at which they bought

them.

Coupon rates are most often fixed the rate of interest stays constant throughout the

life of the bond. However, some bonds have variable or floating coupon rates (interest

payments change from period to period based on a predetermined schedule or formula). Some

bonds pay no interest at all until maturity.

Because bondholders are creditors rather than part owners, if a corporation goes

bankrupt, bondholders have a higher claim on assets than stockholders. This provides added

security to the bond investor but does not completely eliminate risk.

Finally, bonds also trade differently from stocks. Bonds typically trade in the overthe-counter (OTC) market for example, from a broker to a broker at another firm directly

instead of on a stock exchange.

Benefits of Investing in Bonds

The benefits of investing in bonds are:

1. Income predictability

If your objective is to maintain a specific, steady level of income from your portfolio,

high quality bonds can provide a series of predictable cash flows with minimal risk to your

invested capital (the principal).

2. Safety

Depending on their quality, bonds can offer you a high degree of certainty that the

interest and principal repayment will be received in full if the bond is held to maturity. The

quality of the bond and the level of security that comes with it is reflected in the credit

rating of the issuer.

3. Diversification

Diversification means holding a mix of different asset classes in your portfolio. For

example, adding fixed-income securities like bonds to an equity portfolio helps you achieve

greater diversification. This is a way to reduce portfolio risk the risk inherent in your

combined investment holdings while potentially increasing returns over time, since even if

one class declines in value, there is still an opportunity for an increase in one or more of the

other classes.

4. Choice

A wide range of bond issuers with a variety of coupon rates and maturity dates are

available for you to choose from. This allows you to find the bond(s) with cash flows that

match your income needs while complementing your other portfolio holdings.

Risks Of Bond Investing

There are a number of risks to bond investing and, as a rule, investment returns are lower

when risk is low; higher returns mean higher risk. Two key risks are the risk of default and

price risk.

An issuer of debt is said to be in default when the issuer is unable to repay the principle

or interest as scheduled. Government bonds have virtually no risk of default. Corporate bonds

are more exposed to default risk because companies cannot raise taxes when there is a cash

shortfall or take advantage of other options available to governments.

Because the financial health of a company may change during the life of a bond, it is

important to watch for changes. Investors can assess the likelihood of default inherent in a

bond by watching its credit rating.

2. Price risk

If you sell your bonds prior to their maturity, their price or market value may be lower

than the price at which you bought them. Price fluctuates throughout a bonds lifetime and

may be greater or less than its face or principal value.

If you buy a bond below par, you can expect to realize a capital gain when the bond matures;

similarly, if you bought the bond at a premium, you will have a capital loss at maturity.

A bonds price is a function of the bonds coupon rate as compared to the current level of

interest, its remaining term to maturity, its credit or default risk and any special features it

may have.

Coupon rate versus interest rate fluctuations

Fluctuations in interest rates usually have the biggest impact on the price of bonds

interest rates can be affected by many things, including a change in inflation rates. Generally

speaking, bond prices move inversely to interest rates because the coupon rate usually

remains constant through to maturity. If current interest rates are higher than the coupon rate,

the bond is less attractive to investors and drops in value, since investors arent willing to pay

as much for a series of lower coupon payments. Bond prices increase when the coupon rate is

higher than current interest rate levels. To an investor who holds bonds through to maturity,

price fluctuations may seem irrelevant. Not all bond prices react in the same way to interest

rate changes. Usually, the lower the coupon rate, the more sensitive the bond price is to any

changes in rates.

Term to maturity

As bonds approach maturity, their market value approaches their face value. In

general, the longer the term to maturity and the lower the coupon rate, the more sensitive a

bond is to any changes in rate. When interest rates increase, bonds with distant maturity dates

and low coupon rates experience the greatest fall in price.

Risk

As a rule, you can expect to receive a full repayment of a bonds face value on the

maturity date as long as the issuer is able to repay the debt, but if the credit rating changes

during the life of the bond, it may have an affect on the bonds price. For example, if the

credit rating of debt rated AAA the lowest level of default risk changes due to large

losses by the issuing company that could affect the companys ability to repay interest or

principal, the bond price will drop even if there is no change in interest rates.

Special features

Many bonds have special features that may have a significant impact on their price,

risk and the returns you may earn. They can be called (repaid) early or they can be converted,

for example, into shares of the issuing company. Bonds can also be extended (repayment

deferred from the original term to a later date) or other special provisions can apply.

Demand and supply

The availability of bonds and the demand for them also affects the price of bonds. As

demand increases, prices rise, all other factors remaining the same. Also, as the supply of

bonds declines, for example, prices generally also rise. In both cases, if you are holding

bonds, their yield to maturity will increase. Similarly, when demand falls or supply increases,

prices fall and yield to maturity declines.

How to Invest in Bonds

There are three common ways to invest in bonds:

1. Over-the-counter (OTC) market: Individual bonds are not bought on a central exchange.

Instead, they are bought or sold through an investment advisor from inventory in the

advisors brokerage firm or in the OTC market. The price includes any fees for the advisors

services.

When purchasing a newly issued bond (a bond not previously held by another investor), the

investment advisor provides you with a prospectus or other disclosure documents that explain

the bonds terms, features and associated risks and then buys the bond on your behalf in the

primary market. Previously issued bonds are traded in the secondary market.

2. Mutual/investment funds: Bond or balanced mutual funds are an indirect method of

investing in bonds. These products combine professional management with exposure to a

basket of bonds that have varying maturity dates and levels of quality. Like any mutual fund,

a bond or balanced fund may accommodate systematic purchase/withdrawal plans,

reinvestment of distributions and low initial investment requirements.

3. Exchange-traded funds (ETFs): ETFs are mutual fund trusts whose units trade on a stock

exchange, such as the TSX. Some ETFs expose you to an entire bond market index, while

others try to track the performance of a government benchmark bond. Risk levels vary

depending on the ETF selected. Because ETFs are not actively managed, they tend to be

characterized by lower management fees.

How Interest Rates Affect Bond Prices

Interest rates are not all created equal. The longer it takes a bond to reach maturity, the

greater the likelihood that the bonds price will fluctuate and that investors will want to be

rewarded for assuming that extra risk. The yield curve captures the overall movement of

interest rates, giving investors a sense of how rates might change and how bond prices might

be affected. The yield curve tracks interest rates of bonds with different maturities at a set

point in time. There are three basic types of yield curve: normal, inverted, and flat.

The first graph shows, bonds with long maturities usually have a steeper yield curve

than shorter-term bonds because of the risks that occur over time.

The second graph shows an inverted yield curve, with yields of shorter-term securities

higher than those of longer term securities. This can suggest an approaching recession since it

is usually caused by the Federal Reserve Boards raising its target for short-term interest rates

to a high level.

The third graph shows a flat yield curve, with yields of shorter- and longer-term

securities very close to each other. A flat yield curve is usually an indicator of economic

transition. The steeper the slope of the yield curve, the greater the gap between short- and

long-term interest rates.

Rates of Return on Bonds

The rate of return on a bond is computed in the same way as the rate of return on

stock or any asset. It is determined by the beginning and ending price and the cash flows

during the holding period.

Valuation of Bonds

The value of bonds can be described in terms of dollar values or the rates of return

they promise under some set of assumptions. There are basically two types of bond valuation

methods:

1. The present value model, which computes a specific value for the bond using a

single discount value and

2. The yield model, which computes the promised rate of return based on the bonds

current price.

The present value model: We know that the value of a bond (or any asset) equals the

present value of its expected cash flows. The cash flows from a bond are the periodic interest

payments to the bondholder and the repayment of principal at the maturity of the bond.

Therefore, the value of a bond is the present value of the semi-annual interest payments plus

the present value of the principal payment. Notably, the standard technique is to use a single

interest rate discount factor, which is the required rate of return on the bond. We can express

this in the following present value formula that assumes semi-annual compounding

The value computed indicates what an investor would be willing to pay for this bond

to realize a rate of return that takes into account expectations regarding the RFR, the expected

rate of inflation, and the risk of the bond.

The Yield Model: Instead of determining the value of a bond in dollar terms,

investors often price bonds in terms of yields i.e. the promised rates of return on bonds under

certain assumptions. In the previous model we have used we have used cash flows and our

required rate of return to compute an estimated value for the bond. To compute an expected

yield, we use the current market price (Pm) and the expected cash flows to compute the

expected yield on the bond. We can express this approach using the same present value

model. The difference is that in in the previous equation it was assumed that we knew the

appropriate discount rate (the required rate of return), and we computed the estimated value

(price) of the bond. In this case, we still use equation 19.1, but it is assumed that we know the

price of the bond and we compute the discount rate (yield) that will give us the current

market price (Pm).

i = the discount rate that will discount the expected cash flows to equal the current

market price of the bond. This i value gives the expected (promised) yield of the bond

under various assumptions to be noted, assuming you pay the price Pm.

Computing Bond Yields

1. Nominal yield: Nominal yield is the coupon rate of a particular issue.

For eg: A bond with an 8 % coupon has an 8 % nominal yield. This provides a

convenient way of describing the coupon characteristics of an issue.

2. Current yield: Current yield is to bonds what dividend yield is to stocks. It is computed

as

CY = Ci /Pm

Where:

CY = the current yield on a bond

Ci = the annual coupon payment of bond i

Pm = the current market price of the bond

3. Promised yield to maturity: Promised yield to maturity is the most widely used bond

yield figure because it indicates the fully compounded rate of return promised to an

investor who buys the bond at prevailing prices, if two assumptions hold true.

Specifically, the promised yield to maturity will be equal to the investors realized yield

if these assumptions are met. The first assumption is that the investor holds the bond to

maturity. This assumption gives this value its shortened name, yield to maturity (YTM).

The second assumption is implicit in the present value method of computation.

To compute the YTM for a bond, we solve for the rate i that will equate the current

price (Pm) to all cash flows from the bond to maturity. As noted, this resembles the

computation of the internal rate of return (IRR) on an investment project. Because it is a

present valuebased computation, it implies a reinvestment rate assumption because it

discounts the cash flows. That is, the equation assumes that all interim cash flows (interest

payments) are reinvested at the computed YTM. This is referred to as a promised YTM

because the bond will provide this computed YTM only if you meet its conditions:

1. You hold the bond to maturity.

2. You reinvest all the interim cash flows at the computed YTM rate.

4. Computing Promised Yield to Call: Again, the present value method assumes that you

hold the bond until the first call date and that you reinvest all coupon payments at the YTC

rate. To compute the YTC by the present value method, we would adjust the semi-annual

present value equation to give

where

Pm = the current market price of the bond

Ci = the annual coupon payment of bond i

nc = the number of years to first call date

Pc = the call price of the bond

Following the present value method, we solve for i, which typically requires several

computations or interpolations to get the exact yield

5. Realized (Horizon) Yield: The final measure of bond yield, realized yield or horizon

yield (i.e., the actual return over a horizon period) measures the expected rate of

return of a bond that you expect to sell prior to its maturity. The realized yields over a

horizon holding period are variations on the promised yield equations. The

substitution of Pf and hp into the present value model provides the following realized

yield model:

Reference

Bhalla. V. K. (2014). Investment Management. Security Analysis and Portfolio Management.

New Delhi.

The Vanguard Group, Inc. (2015). Learn about Bond Investing. Investor education. Pg. 1-24

- Test Bank - Problems and Essays 2008Enviado porokkie
- 02-2 Market Risk Premium and Risk Free Rate SurveyEnviado porsilversuave
- All About BondsEnviado porDrEwPablo
- Fin 370 GeniusEnviado pordavid
- ch 11Enviado porSweetCherrie
- Investment Outlook: Navigating through risky watersEnviado porSEB Group
- Managing Bond Portfolios Ch16 ActivepassivEnviado porKumar
- Primer for Investing in BondsEnviado porlondonmorgan
- Exam_1Enviado poradam2119
- Lecture 8 NotesEnviado porHe Nry So Ediarko
- US Internal Revenue Service: 2007p1212 sect i-iiiEnviado porIRS
- Ch12 Solutions UploadEnviado pordbjohnstone
- 2017 GMI - Real Vision - MacroEnviado portomwillems6496
- p4 articleEnviado porDianna Redzuan
- Advanced MathsEnviado porpreeti.2405
- Exam1Sp11Enviado porHanna Gao
- Sav Pdp 0036Enviado porMichael
- US Treasury: ps-1991-q1Enviado porTreasury
- Stocks and BondsEnviado porJeffrey Del Mundo
- Blackrock Sovereign Risk Update.pdfEnviado porpeter_martin9335
- investments assignmentEnviado porapi-276231812
- Practice QuestionsEnviado porDimple Pandey
- Proposal Cob DormsEnviado porcjackson1066
- Financing ExtractEnviado porNavin Jalwania
- US Treasury: ps-1995-q2Enviado porTreasury
- ApplicationsEnviado porPawan Yadav
- 5 - 5th October 2016_tcm12-12781.pdfEnviado porsharktale2828
- Investments 8th Canadian Edition Test BankEnviado porBettyCastillo2
- HW 06 CorrectionEnviado pordhruvg14
- 3 Questions (1)Enviado porPrasant Goel

- Building a Credit Risk ValuationEnviado porMazen Albshara
- ACC Quiz 1Enviado porKai Green
- Basics of DerivativesEnviado porJay Shah
- HDFC Sec_Navin Fluorine International_Q4FY17_02052017.pdfEnviado porRonak Jajoo
- GAO Report: Status of Government Assistance Provided to AIGEnviado porldelevingne
- Report and Financial Statements September_2017Enviado porShawlin Rishad Hoque Antora
- MUDARABAH 2Enviado porJelena Cienta
- Hbl ReportEnviado porAli Shahan
- CSE Annual Report 2013Enviado porGayanChandrasekara
- ratio analysisEnviado porRicha Sagar
- Grant Thornton IPOEnviado porZerohedge
- The Relationship Between New Issue Markets and Stock ExchangeEnviado porકાશ ઠક્કર
- Fixed AssetsEnviado porhadeel
- IFRIC 13_Customer Loyalty ProgrammesEnviado porTopy Dajay
- Ebit Eps AnalysisEnviado porpranajaya2010
- Chapter 05 Risk and Return: Past and PrologueEnviado porsaud1411
- EFERT - BMAEnviado porsaaaruuu
- Securion I Fund LLP - Operating AgreementEnviado porRaymond Di Francese
- Shriram_tranEnviado porvenkateshv_venki
- 1000 companies to inspire EuropeEnviado porLe Monde
- EquityEnviado porAvinash Das
- SM Chap013Enviado porNicky 'Zing' Nguyen
- The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement IncomeEnviado porWiley Canada
- Exercises Lesson 3 0809Enviado porChrisYap
- IAS-1-–-Presentation-of-Financial-StatementsEnviado porm2mlck
- Finance Summaries 100Enviado porPZ
- IAS 36 - Impairment of AssetsEnviado porAngelCea_04
- CitiChoice-IR4Enviado porVishal Rastogi
- Investment Appraisal LectureEnviado porviettuan91
- e 233138Enviado porAKASH