Fixed 

income securities

Tomasz Schabek, Ph.D.

Tomasz Schabek, Ph.D.
 Book:

Fabozzi, Frank J. (2009). Bond Markets, Analysis 
g pp
and Strategies: 7th edition. Upper Saddle 
River, NJ: Prentice Hall
 Program
1. IIntroduction
1 t d ti
a) Definition and properties
b) Risk of investing in bonds

2. Bonds’ pricing
p g ‐ Time value of money. Valuation of bonds, 
y ,
quotations of bonds, bonds’ prices sensitivity for changes 
of interest rates – introduction

3. Measuring Bonds Yield, portfolios of bonds. Types of yields 

of bonds – understanding and calculations. Valuation of 
the portfolio of the bonds ‐ practical calculations
 Introduction
Definition and properties
Bond is financial instrument of
instrument of which the issuer
(borrower, seller) is obligated to return of
borrowed amount of money to theto the investor
(lender, buyer) plus the interest over agreed
period off time.
 Introduction
• Value (price)

Value of the bond is equal to the sum of all 
di
discounted cash flows connected to this 
d h fl d hi
bond.
 Introduction
Each bond has the nominal value, (also called: 
principal value, face value, par value)
p p p ) ((let’s 
mark it: „N”) – it is the amonut of money that 
is borrowed by issuer from investor usually its
is borrowed by issuer from investor, usually its 
equall to ‘round’ values like 100, 1000, 100000 
(units of money e g PLN USD JPY)
(units of money, e.g. PLN, USD, JPY). 
Nominal value is usually the last and largest cash 
flow of the bond.
 Introduction
Each bond has the expiry date (maturity date) –
it is the date on issuer is obligated to return 
g
the nominal value of borrowed money to the 
investor (it is the particular date e g
investor (it is the particular date, e.g. 
01.04.2026)
Lets mark it as „T”
k ”
 Introduction
• Properties
i – nomenclature
l

Each bond has the expiry period (term to 

maturity or just maturity) 
maturity, or maturity) – it is the period 
period
from the moment of purchasing the bond to 
the maturity date (measured
date (measured usually in
number of periods, like: years, quarters, etc.).

Lets mark it as „t”

 Introduction
• Properties
P i – nomenclature
l

Each bond has the coupon rate (interest rate, nominal 
rate) – it is the interest rate (in %) to be applied to 
nominal value that is used to calculate how much
nominal value that is used to calculate how much 
money (coupon, interest – measured in money units, 
e.g.: USD, PLN, EUR) the investor will receive in whole
e.g.: USD, PLN, EUR) the investor will receive in whole 
year. 
Coupons are usually most numerous of the cash flows of 
p y
the bond, but sometimes coupon rate can be = 0.
p p q
If coupon rate = c then the coupon is equal: C = c *N
 Introduction
Each bond has the yield (discount rate, yield‐to‐
y q
maturity, YTM, required rate of investment)  )
that will be used to discount each of the cash 
flows connected to the bond
flows connected to the bond. 

Do NOT confuse yield and interest (coupon) rate 
!
 Introduction

Basic properties of the bond - summary:

● Kind of issuer

● Term to maturity

● Nominal value and coupon rate, yield

● Additional options
 Introduction
Kind of issuer:
G
Governments
t

Administrative units (like regions,

regions states,
states cities)

Corporation
 Introduction
Term to maturity:
● 1 tto 5 years – short
h t term
t bonds
b d

● 5 to 12 years – medium term bonds

● More then 12 years – long term bonds

 Introduction
Nominal value and coupon rate, yield

- Safe bonds (high ratings, AAA bonds)

- Investment grade bonds
- Speculative bonds (high yield bonds,
bonds
junk bonds)
 Introduction
Additional options

- Options embedded in the bond that

give
i some rights
i ht to
t the
th buyer
b or seller
ll
like right to premature selling or
premature redepmtion of the bond,
converting the bond to shares, etc.
 Introduction
Risk of investing in bonds
1. Interest rate risk

2 R
2. Reinvestment
i t t risk
i k

3. Call risk – premature redemption of the bond

4. Credit risk – default risk

5. Inflation risk

6. Exchange rate risk

7. Liquidity risk

8. Volatility risk (especially for option-embedded bonds)

9. „Risk risk” (not knowing what the risk of investment is)