Chapter 6 Flashcards
(20 cards)
Bond
A security issued by governments and corporations to raise money from investors today in exchange for promised future payments
Maturity date
Date at which the final repayment is made
Time remaining until the maturity date
Term of the bond
Types of payments of the bond
Coupon –> promised interest payments of a bond
–> Coupon rate: the amount of each coupon payment
Principal or face value –> value paid at maturity
Zero coupon bonds
Or pure discount bonds
Bonds that don’t make coupon payments
–> Only pay the face value at the maturity date
Trade at a discount
YTM
Rate at which the PV of the promised bond payments equals the current market price of the bond
–> The IRR of an investment in a bond
–> Per-period rate of return for holding the bond from now until maturity.
Risk Free Interest Rate with Maturity n
rn = YTMn
Trading at a discount
P < FV
YTM > Coupon rate
Trading at a premium
P > FV
YTM < Coupon rate
Trading at a par
P = FV
YTM = Coupon rate
As interest rates and bond yields rise
Bond prices will fall
If the yield curve is upward sloping
The yield to maturity decreases with the coupon rate of the bond
If the yield curve is downward sloping
The yield to maturity increases with the coupon rate of the bond
Corporate bonds
Bonds issued by corporations
Hold credit risk –> risk of default
Bonds with a higher risk of default
Pay less
Higher YTM –> reward for the risk
Top 4 categories of bonds
Investment grade bonds
Bottom 5 categories of bonds
Speculative bonds, junk bonds, high yield bonds
Sovereign bonds
Bonds issued by national governments
Increase coupon
Decrease sensitivity –> money comes back to you sooner so you are less affected by future changes in interest rates
Increase maturity of the bond
Increase sensitivity
