Bond Basics

1. 4 key characteristics of a bond:

(a) Issuer Corporation, Municipality, Government,
International. Government is more secure than any
corporation since its default risk is extremely small (US
governments known as risk-free assets)
(b) Priority Junior/Subordinated, Senior Unsubordinated: In
the case of default, creditors with unsubordinated debt paid
in full then subordinated get paid; Subordinated debt is more
risky than unsubordinated therefore subordinated debt
usually have higher interest rate
(c) Coupon Rate Fixed Income (fixed percentage of par
value), Floater (adjustable interest payment), Inverse Floater
(inverse relationship to benchmark rate), Zero Coupon
(doesnt pay coupon but traded at deep discount): The
amount the bondholder will receive as interest payments;
Can be paid monthly, quarterly, annually or every 6 months.
(d) Redemption Features Callable (redeemed by issuer prior
to maturity, when interest rate declines), Convertible (can be
converted into a predetermined amount of the companys
equity at certain times during its life to minimize negative
investor interpretation of its corporate actions), Puttable
(allows holder to force issuer to repurchase at specified dates
before maturity, repurchase price set at time of issue and
usually par value): Upon maturity or cancellation by the
issuer.
2. Interest rate risk is the risk that an investment value will change
due to the fluctuating interest rates in absolute level. As interest
rates increase, bond prices fall. When interest rates increase,
investors can get a higher yield by switching to other
investments that gives higher interest rate and this causes bond
prices to decrease.
3. Duration is a measure of sensitivity of the bond price to a
change in interest rates and is expressed as a number of years.
Duration is highest for a zero coupon bond compared to a
coupon paying bond. Duration of a zero coupon bond is equals
to its year to maturity whereas coupon paying bond has duration
that is less than its maturity. The higher the duration, the higher
the interest rate risk.
4. Coupon rate is the actual amount of interest income that will be
earned each year based on the bonds face value. A bonds
yield to maturity tells you how much you will be paid in the
future which is an estimated rate of return that assumes the
bond is held until maturity. In order to calculate yield to
maturity, the coupon rate is taken into account in its calculation.

5. CR 0.08, FV 10000, Maturity 10, Paid in semi-annual

coupon
(a) Interest rate falls to 6% - New market price of the bond should
be $11487.75
(b) The price of the bond would be $10000 if the interest rate was
8% compounded semi-annually
6. (a) The market price of a 10 years coupon bond is $8753.78
whereas for a 30 years coupon bond is $8107.07
(b) Market price of a 10 years coupon bond after an increase
in interest rate by 1 basis point is $8748.08 whereas for a 30
years coupon bond is $8099.20
(c) Market price of a 10 years coupon bond after a decrease
in interest rate by 1 basis point is $8759.48 whereas for a 30
years coupon bond is $8114.96
(d) If we look at the normal yield curve:

The yield curve is steeper in the beginning and then flattens

as the number of years increases. The change in yield is nonconstant which is why a constant increase/decrease in yields
lead to a non-constant decrease/increase in values.
7. C

8. Coupon 10, FV 100, Price 100.417, n =3

Yield to Maturity is 9.63%
9. The 4 factors affecting bond yields are :
(a) Interest Rates As interest rates increases, bond prices
fall
(b) Inflation When inflation increases, bond prices fall. This
is because increasing inflation decreases the purchasing
power which means when the bond matures, the return
earned from the investment is worth less in todays dollars.
(c) Credit Ratings Credit rating is assigned to bond issuers
and to specific bonds which provide information about the
issuers ability to make interest payments and repay the
principal of a bond. The higher the credit ratings, the more
likely an issuer can meet its payment obligations. When
credit ratings increases, the bond price increases.
(d) Demand and Supply When the demand for bond
increases, bond price increases whereas when the supply
for bond increases, bond price decreases.
10.
There are 4 types of yield curve:
(a) Normal Yield Curve Yield increases as maturity
lengthens and the slope of the yield curve is positive
(b) Flat Yield Curve When all maturities have
approximately the same yield
(c) Humped Yield Curve When short-term and long-term
yields are equal and medium-term yields are higher than
those of the short and long term.
(d) Inverted Yield Curve When long-term yields falls below
short-term yields