chapter 10: bond prices and yields

What is a bond?

A debt security where the issuer promises to pay fixed interest (coupon) and repay face value at maturity.

What is a zero-coupon bond?

A bond that pays no periodic interest; it's sold at a discount and repays full face value at maturity.

What’s the difference between a premium bond and a discount bond?

Premium: Price > Par; Coupon > YTM.
Discount: Price < Par; Coupon < YTM.

What is the coupon rate?

Annual interest paid by a bond, expressed as a % of face value.

What is the yield to maturity (YTM)?

The discount rate that makes the present value of bond payments equal to the current price — an estimate of total return if held to maturity.

What’s current yield?

Annual coupon payment ÷ current market price.

What is a callable bond?

A bond that can be repaid early by the issuer at a set call price. Investors demand higher yields for this risk.

What is a put bond?

A bond that the holder can sell back to the issuer at a predetermined price before maturity.

What is a convertible bond?

A bond that can be converted into a set number of the issuer's shares. Typically has lower coupon rates.

What are floating-rate bonds?

Bonds where interest payments adjust based on a market rate plus a fixed spread.

Why are bond prices and yields inversely related?

As yields rise, present value of future cash flows falls, lowering bond prices.

What is reinvestment rate risk?

Risk that coupons received will be reinvested at a lower rate than the bond’s YTM.

What is the realized compound return?

The actual return on a bond accounting for reinvested coupons.

What is a default premium?

Extra yield to compensate for the risk of issuer default.

What’s the difference between investment-grade and speculative-grade (junk) bonds?

Investment-grade: Low risk of default (rated BBB or higher).
Speculative/junk: Higher risk, rated below BBB.

What is collateral in bond terms?

Assets pledged to secure repayment (e.g., property, equipment).

What is a sinking fund?

A fund into which the issuer sets aside money to repay bonds gradually.

What are subordination clauses?

Specify that certain debt holders are paid only after other senior obligations are met.

What is a credit default swap?

Insurance-like contract that pays if a bond defaults. The buyer pays a premium; the seller covers loss in default.

What is the term structure of interest rates?

Relationship between bond yields and maturities — visualized via the yield curve.

What does the yield curve show?

Yields on bonds of equal credit quality across maturities. Upward-sloping = longer terms have higher rates.

What is a forward rate?

The future interest rate implied by today’s bond yields — breakeven for investing long vs. rolling short.

What is the expectations hypothesis?

Assumes forward rates = expected future short-term rates.

What is the liquidity preference theory?

Investors demand a liquidity premium for longer-term bonds due to uncertainty.

Catastrophe bond

Pays higher yields, risk of default tied to disaster events

Eurobond

Bond issued in a currency not native to the country of issuance

Samurai bond

Yen-denominated bond issued in Japan by a foreign firm

Indexed bond

Payments tied to inflation index

Original-issue discount bond

Issued at a discount, no regular interest

Serial bond

Multiple maturities over time

Equipment obligation bond

Secured by physical assets

Junk bond

High yield, high risk (non-investment grade)