Muhammad Usman Roll No 113

Topics
Properties of bonds Rating of risk Interpreting the price of bond Interest rate, inflation and exchange rate with bond price and return

Properties of bonds
Inherent qualities or natural qualities of bonds which are
Maturity Coupon Current yield Yield to maturity Duration

Maturity
This is the date on which the bond issuer will have repaid all of the principle and will redeem the bond There are three Maturity levels 1. Short term (1 to 5 years usually) 2. Medium term (5 to 12 years) 3. Long term (exceeding 12 years)

Coupon
This is the stated annual rate as a percentage of the price at issuance Coupon never changes Once a bond issued.

Current yield
Current yield is the effective interest rate for a bond at its current market price. Formula:
Current yield= Annual dollar coupon interest current price

If price has fallen then current yield greater than coupon and vice versa.

Yield to maturity

This is the annual rate the bond holder will receive if the bond is held to maturity

Duration
It is a measurement of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows. 1.

Duration
Zero-Coupon Bond Duration is equal to its time to maturity

Duration
Coupon bond:
Duration will always be less than its time to maturity

Rating of risk
Rating agencies which investigate Issuers ability to service the bonds include
Financial strength

Use of fund Regulatory environment Potential economic changes Political environment

What bonds rating mean

Rating agencies use different methodologies only of probability of default not financial distress or price of bond.
AAA: issuer has strong ability to meet obligation AA: low risk of default A: high credit quality but vulnerable to changes in economy BBB: Adequate credit quality BB : Below investment grade but chance that issuer can meet commitment B: Significant credit risk but issuer presently able to meet obligation CCC: high default risk C or D: Issuer failed to meet scheduled interest or principle payment Good rating has increase the value of bond but decrease the coupon due to less risk

Interpreting the price of bond

The price of bond is normally quoted as a percentage of the price which the bond was issued.
A bond quote above 100 means that the bond is trading above par A bond quote below 100 means that the bond is trading below par. A bond's price moves inversely to its yield

Interest rate and bond price with current yield

Inflation and return on bonds

Interest rate can be thought of as having two separate component.
compensate for inflation bond investor demand for use of its money

Indicator of future inflation

Employment Wages increases Commodity price Industrial capacity utilization

if the inflation increase then the price of bond must fall.

Exchange rate and bond price and return

Investor invest in bonds those countries where a chance to increase the value of currency in future Or when a chance the home currency decrease in future So the strengthening of a country's currency increase the demand for its bonds