Bond Markets

Extract

[...] Bond Markets Different types of financial markets Bond: financial obligation of a borrower towards lenders Stream of future value characterized by: face/par value maturity guarantees issue date coupon/interest rate payments Price of a bond: present value of the cash flow it generates Price of a bond usually given as a percentage of the par value: Par/face value: value of the financial instrument the time it is issued - if r coupon rate bond priced at discount to its par value - if r = coupon rate bond priced at par value Yield to maturity: discount rate equals PV of future cash flow and market price Cash flows (coupon + principal) are fixed But YTM may change over the life of the bond because of changes in inflation expected; risk free rate; risk premium Market value of the bond may change over its life Price of bonds moves inversely to YTM Bond price volatility/risk Sensitivity (modified duration): absolute value of a percentage change in the bond price with respect to a change in the YTM Duration: average time of cash flow weighted by the fraction of the total value of the bond Bonds with longer maturity more sensitive to YTM Bonds with more back-loaded payments more sensitive to YTM Bonds with higher coupon payment less sensitive to YTM Bonds with higher YTM less sensitive to YTM Risk measurement Instantaneous change in the bond's yield: low coupon bonds are more sensitive duration measured in years low yield bonds have higher duration and are more sensitive Duration measures the time at which total value of the bond is not sensitive to interest rate variations measures the time you must hold the bond to be protected against the risk of fluctuations in interest rates. [...]