Bond Basic
The two types of future cash flows a bondholder receives.
What are interest (coupon) payments and repayment of principal
The market rate used to discount a bond’s future cash flows.
What is the yield to maturity (or market interest rate)
The relationship between bond prices and interest rates.
What is an inverse relationship
Current Yield = Annual Interest Payment divided by this.
What is the price of the bond
The realized return on a bond may differ from YTM if these market conditions change.
What are interest rates or reinvestment rates
The term for the bond’s regular interest payment.
What is a Coupon Payment
The approximate value of a $1,000 bond paying $60 per year for 3 years at 8%.
What is $948.62
The average number of years until a bond’s cash flows are received.
What is duration
The current yield of a 6% coupon bond priced at $948.62.
What is approximately 6.33 percent
When interest rates rise, the present value of future payments does this.
It decreases
The amount repaid to the bondholder at maturity.
What is the Principle of Face Value
The calculator function used to find a bond’s price.
What is the present value (PV) function
The economic factor that longer-duration bonds are most sensitive to.
What are changes in interest rates
The yield that accounts for both current income and price change if held to maturity.
What is the yield to maturity (YTM)
A bondholder discounting future payments at a higher rate is selling at this.
What is a discount
When a bond’s price equals the coupon × PVAIF plus this value × PVIF.
What is the principal amount or par value
What happens to a bond’s price when interest rates rise.
It falls (or sells at a discount)
Duration measures the approximate percent change in price for this 1% change.
What is a 1 percent change in interest rates
For a discount bond, this yield is higher than the current yield.
What is the yield to maturity
The key feature ignored by current yield but included in YTM.
What is the bond’s premium or discount from par value
When the market rate equals the coupon rate, the bond sells at this value.
What is par value ($1,000)
What happens to bond prices when interest rates fall.
They rise (or sell at a premium)
Between a 10-year and 20-year bond, this one has the higher duration.
What is the 20-year bond
YTM assumes the bond is held to maturity and that this happens to each coupon payment.
What is reinvestment of interest payments
Higher rates lower a bond’s value because cash flows are discounted more heavily—illustrating this principle.
What is the inverse relationship between interest rates and bond prices