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2


Ý Introduction
Ý Bond Returns
 coupon rate
 current yield
 spot interest rate
 yield to maturity
 yield to call
Ý Bond Prices
Ý Bond Pricing eorems
Ý Bond Risks
Ý Bond Duration
u
I
R DU2I

Ý Bonds are Long-term fixed income
securities. Debentures are also long-term
fixed income securities. Bot of tese are
P
  .

Ý e two major categories of bonds are

’


P    
P

Ý ere are te two main features of bonds

suc as  
 P



B
D RUR

Ý 2 UP
RA-

It is te nominal rate of interest fixed

and
printed on te bond certificate. It is calculated
on
te face value of te bond. It is te rate at
wic
interest is payable by te issuing company to
te
bondolder.


B
D RUR
 (2
.)
Ý 2URR
 YILD-
e current market price of a bond in te secondary
market may differ from its face value.
e current yield relates te annual interest
receivable on a bond to its current market price. It can
be expressed as follows-
~


   

Were
In = Annual Interest
Po = 2urrent market price

O
B
D RUR
 (2
.)
Ý P  I
R RA-
 -ero coupon bond is a special type of bond wic does
not pay annual interests.

 e return on tis bond is in te form of a P   

   
P.

 is type of bond is also called  P  
P 

P P  
P.

 pot interest rate is te annual rate of return on a bond

tat as only one cas inflow to te investor.

è
B
D RUR
 (2
.)
Ý YILD  MAURIY (YM)-
is is te most widely used measure of
return on bonds.
It may be defined as te compounded rate of
return an investor is expected to receive
from a bond purcased at te current
market price and eld to maturity.
It is really te internal rate of return earned
from olding a bond till maturity.
YM depends upon te cas outflow for
purcasing te bond, tat is, te cost or

[
B
D RUR
 (2
.)
2urrent market price of te bond as well as te
cas inflows from te bond, namely te future
interest payments and te terminal principal
repayment.
YM is te discount rate tat makes te present
value of cas inflows from te bond equal to te
cas outflow for purcasing te bond.
e relation between te cas outflow, te cas
inflow and te YM of a bond can be expressed
as
MP = 2t 
(1 + YM)t (1 +
YM)n

ñ
B
D RUR
 (2
.)

Were -
MP = 2urrent market price of te
bond
2t = 2as inflow from te bond
trougout te olding period.
 = erminal cas inflow received at
te end of te olding
period.

D
B
D PRI2I

 RM
e relation between bond prices and canges in
te market interest rates ave been stated by Burton .
Malkiel in te form of five general principles. ese are
known as Bond pricing teorems.

e five principles are-

Ý Bond prices will move inversely to market interest
canges.

Ý Bond price variability is directly related to te term to

maturity; wic means, for a given cange in te level of
market interest rates, cange in bond prices are greater
for longer-term maturities.

Y
B
D PRI2I

 RM(2
..)

Ý A bond·s sensitivity to canges in market

interest rate increases at a diminising rate
as te time remaining until its maturity
increases.

Ý e price canges resulting from equal

absolute increases in market interest rates
are not symmetrical, i.e. for any given
maturity, a decrease in market interest rate
causes a price rise tat is larger tan te
price decline tat results from an equal
increase in market interest rate.

YY
B
D PRI2I

 RM (2
..)

Ý Bond price volatility is related to te

coupon rate, wic implies tat te
percentage cange in a bond·s price due
to a cange in te market interest rate
will be smaller if its coupon rate is iger.

Yu
B
D RI

wo types of risk are associated wit

investment in bonds, namely P  
and      .

Ý DAUL RI-
Default risk refers to te
possibility tat a company may fail to pay
te interest or principal on te stipulated
dates. Poor financial performance of te
company leads to suc defaults.
Y
B
D RI (2
..)

Ý I
R RA RI-

e risk tat an investment's
value will cange due to a cange in te
absolute level of interest rates. uc
canges usually affect securities inversely
and can be reduced by diversifying or
edging.
Interest rate risk affects te
value of bonds more directly tan stocks,
and it is a major risk to all
bondolders.As interest rates rise, bond Y
B
D DURAI

Ý Duration is te weigted average measure

of a bond·s life. e various time periods
in wic te bond generates cas flows
are weigted according to te relative
size of te present value of tose flows.
Ý e formula for computing duration P is-
() (2t)
d= (1 + )t
2t
t
(1 + k) YO
B
D DURAI
(2
..)

Were -
2t = Annual cas flow including
interest & repayment
of principal.
=
olding period.
 = Discount rate wic is te
market interest rate.
 = e time period of eac cas
flow.
Yè