BONDS

 Bonds are units of corporate debt issued by companies and securitized as tradeable
assets. A bond could be thought of as an I.O.U. between the lender and borrower that
includes the details of the loan and its payments. Bonds are used by companies,
municipalities, states, and sovereign governments to finance projects and operations.
Owners of bonds are debtholders, or creditors, of the issuer.
 A bond is referred to as a fixed-income instrument since bonds traditionally paid a fixed
interest rate (coupon) to debtholders. Variable or floating interest rates are also now
quite common.
 Bond prices are inversely correlated with interest rates: when rates go up, bond prices
fall and vice-versa.
 Bonds have maturity dates at which point the principal amount must be paid back in full
or risk default.
ISSUER OF BONDS
Similarly, corporations will often borrow to grow their business, to buy property and
equipment, to undertake profitable projects, for research and development, or to hire
employees. The problem that large organizations run into is that they typically need far more
money than the average bank can provide. Bonds provide a solution by allowing many
individual investors to assume the role of the lender. Indeed, public debt markets let thousands
of investors each lend a portion of the capital needed. Moreover, markets allow lenders to sell
their bonds to other investors or to buy bonds from other individuals—long after the original
issuing organization raised capital.
When companies or other entities need to raise money to finance new projects, maintain
ongoing operations, or refinance existing debts, they may issue bonds directly to investors. The
borrower (issuer) issues a bond that includes the terms of the loan, interest payments that will
be made, and the time at which the loaned funds (bond principal) must be paid back (maturity
date). The interest payment (the coupon) is part of the return that bondholders earn for loaning
their funds to the issuer. The interest rate that determines the payment is called the coupon
rate.

Characteristics of Bonds
Most bonds share some common basic characteristics including:

 Face value is the money amount the bond will be worth at maturity; it is also the
reference amount the bond issuer uses when calculating interest payments. For
example, say an investor purchases a bond at a premium of $1,090, and another
investor buys the same bond later when it is trading at a discount for $980. When the
bond matures, both investors will receive the $1,000 face value of the bond.
 The coupon rate is the rate of interest the bond issuer will pay on the face value of the
bond, expressed as a percentage. For example, a 5% coupon rate means that
bondholders will receive 5% x $1000 face value = $50 every year.
  Coupon dates are the dates on which the bond issuer will make interest payments.
Payments can be made in any interval, but the standard is semiannual payments.
 The maturity date is the date on which the bond will mature and the bond issuer will pay
the bondholder the face value of the bond.
 The issue price is the price at which the bond issuer originally sells the bonds.
Bonds that are not considered investment grade, but are not in default, are called “high
yield” or “junk” bonds. These bonds have a higher risk of default in the future and investors
demand a higher coupon payment to compensate them for that risk.
Bonds and bond portfolios will rise or fall in value as interest rates change. The sensitivity to
changes in the interest rate environment is called “duration.” The use of the term duration in this
context can be confusing to new bond investors because it does not refer to the length of time
the bond has before maturity. Instead, duration describes how much a bond’s price will rise or
fall with a change in interest rates.
The rate of change of a bond’s or bond portfolio’s sensitivity to interest rates (duration) is
called “convexity.” These factors are difficult to calculate, and the analysis required is usually
done by professionals.

FORMULA

Bond Face Value

Coupon Rate=
Annual Coupon Payment
The formula indicates the possible income of the business for one year in a bond. If a bond has
a face value of $1,000 and made interest or coupon payments of $100 per year, then its coupon
rate is 10% ($100 / $1,000 = 10%). However, sometimes a bond is purchased for more than its
face value (premium) or less than its face value (discount), which will change the yield an
investor earns on the bond.
$ 100
Coupon Rate=
% 1,000
=10%
Since Annual Coupon Payment is not constant, the actual return will depend on how long the
business will hold the bond and its price when they sell it.

Yield to Maturity
A bond's yield to maturity (YTM) is equal to the interest rate that makes the present value of all
a bond's future cash flows equal to its current price. These cash flows include all the coupon
payments and its maturity value. Solving for YTM is a trial-and-error process that can be done

on a financial calculator, but the formula is as follows:

In the previous example, a bond with $1,000 face value, five years to maturity, and $100 annual
coupon payments was worth $927.90 in order to match a YTM of 12%. In that case, the five
coupon payments and the $1,000 maturity value were the bond's cash flows. Finding the
present value of each of those six cash flows with a discount or interest rate of 12% will
determine what the bond's current price should be.
Bond Example
A bond represents a promise by a borrower to pay a lender their principal and usually
interest on a loan. Bonds are issued by governments, municipalities, and corporations. The
interest rate (coupon rate), principal amount, and maturities will vary from one bond to the next
in order to meet the goals of the bond issuer (borrower) and the bond buyer (lender). Most
bonds issued by companies include options that can increase or decrease their value and can
make comparisons difficult for non-professionals. Bonds can be bought or sold before they
mature, and many are publicly listed and can be traded with a broker.
While governments issue many bonds, corporate bonds can be purchased from
brokerages. If you're interested in this investment, you'll need to pick a broker. Because fixed-
rate coupon bonds will pay the same percentage of their face value over time, the market price
of the bond will fluctuate as that coupon becomes more or less attractive compared to the
prevailing interest rates.
Imagine a bond that was issued with a coupon rate of 5% and a $1,000 par value. The
bondholder will be paid $50 in interest income annually (most bond coupons are split in half and
paid semiannually). As long as nothing else changes in the interest rate environment, the price
of the bond should remain at its par value.
However, if interest rates begin to decline and similar bonds are now issued with a 4%
coupon, the original bond has become more valuable. Investors who want a higher coupon rate
will have to pay extra for the bond in order to entice the original owner to sell. The increased
price will bring the bond’s total yield down to 4% for new investors because they will have to pay
an amount above par value to purchase the bond.
 On the other hand, if interest rates rise and the coupon rate for bonds like this one rises
to 6%, the 5% coupon is no longer attractive. The bond’s price will decrease and begin selling at
a discount compared to the par value until its effective return is 6%.
How Do Bonds Work?
Bonds are a type of security sold by governments and corporations, as a way of raising
money from investors. From the seller’s perspective, selling bonds is therefore a way of
borrowing money. From the buyer’s perspective, buying bonds is a form of investment because
it entitles the purchaser to guaranteed repayment of principal as well as a stream of interest
payments. Some types of bonds also offer other benefits, such as the ability to convert the bond
into shares in the issuing company’s stock.
The bond market tends to move inversely with interest rates because bonds will trade at
a discount when interest rates are rising and at a premium when interest rates are falling.
What Is an Example of a Bond?
To illustrate, consider the case of XYZ Corporation. XYZ wishes to borrow $1 million to finance
the construction of a new factory but is unable to obtain this financing from a bank. Instead, XYZ
decides to raise the money by selling $1 million worth of bonds to investors. Under the terms of
the bond, XYZ promises to pay its bondholders 5% interest per year for 5 years, with interest
paid semiannually. Each of the bonds has a face value of $1,000, meaning XYZ is selling a total
of 1,000 bonds.

Bonds are a type of investment designed to aid governments and corporations to raise money.
It can be viewed as a type of loan. There is no stock ownership and dividends, but investors
who purchase bonds do receive payment in the form of interest.
There are broadly two types of bonds:
Government bonds. When the government needs money, they can only issue bonds.
Corporate bonds. Businesses issue bonds instead of seeking a loan or overdraft from the bank
as interest rates are cheaper on bonds and the bond market offers better terms.
Bonds are a safer investment. It is important to note that bonds are not completely risk-free and
only receive preference in case of bankruptcy. Bonds come with much less downside volatility.
Bond investments play a key role in balancing and reducing the short-term volatility associated
with stocks.
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YTM Calculation
ABC Corporation bonds have 12 years remaining to maturity. Interest is paid annually the bonds
have $1,000 par value and the coupon interest rate is 10%. The bonds sell at a price of $850.
What is their yield to maturity?
Where:
F is the par value of the bond
P is the price of the bond
n is the time to maturity of the bond
C is the Annual coupon amount

The values provided in the questions are.

Par Value = $1000.0
Market Value = $850
Annual Rate = 10%
Maturity in Years = 12 years
Payments: Annually
Using the YTM approximation method below the approximate YTM Value will be;