Chapter 3: Bond valuation (Valdone)

Debt markets - are used by both firms and governments to raise funds for long-term purposes,
though most investment by firms is financed by retained profits. Bonds are long-term borrowing
instruments for the issuer
Coupon - bonds pay a fixed rate of interest
Redemption date - as time passes, the residual maturity of any bond shortens
Par or Redemption value - This is also the price at which bonds are first issued
Interest yield (or running yield) - the return on a bond taking account only of the coupon
payments
Yield to maturity or redemption yield -the return on a bond taking account of the coupon cash
flows and the capital gain or loss at redemption
Callable bonds - can be redeemed at the issuer’s discretion prior to the specified maturity
(redemption) date. Putable bonds can be sold back to the issuer on specified dates, prior to the
redemption date
Convertible bonds -these are usually corporate bonds, issued with the option for holders to
convert into some other asset on specified terms at a future date
Eurobonds are bonds issued in a country other than that of the currency of denomination thus
bonds issued in US dollars in London are eurobonds, as are yen bonds issued in New York
Floating rate notes (FRNs) - These are corporate bonds where the coupon can be adjusted at
pre-determined intervals. The adjustment will be made by reference to some benchmark rate,
specified when the bond is first issued
Foreign bonds -these are corporate bonds, issued in the country of denomination, by a firm
based outside that country
Index-linked bonds -These are corporate bonds where the coupon can be adjusted to high and
variable rates of inflation
Junk bonds - are corporate bonds whose issuers are regarded by bond credit rating agencies as
being of high risk
Covered bonds - are claims of the bond holders against the issuing MFI that are secured by a
pool of cover assets on the MFI’s balance sheet, such as mortgage loans or loans to the public
sector
Liquidity - is the ease with which an investor can sell or buy a bond immediately at a price close
to the mid-quote
Liquid market - allows market participants to trade at low trading costs
Liquidity premium - the spread between the yield of a bond with liquidity and a similar bond
with less liquidity
Clean price - the price of a bond ignoring any interest which may have accrued since the last
coupon payment
Dirty price - the price of a bond, including any accrued interest
Realized compound yield - is the average compound rate of return actually obtained from an
investment
Duration - is important for the structuring of bond index tracker funds
Convexity - is a measure of the change in duration with respect to changes in interest rates
Inverse floater - is a bond whose interest rate is inversely related to a market rate
Floating rate note - is a bond whose coupon rate moves in line with market rates