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What is a Bond?

what is a bondWhat is a bondIt is a corporate or government debt instrument. It represents a loan to the company from the investing public. In this case, the company is the borrower and the investor is the lender. Companies issue bonds to raise money for business investments.

What is a Bond?

A bond has a par value, a maturity date, and a coupon rate. The maturity date is the date the company must repay the investor an amount equal to the par value. The par value is the amount the lender will receive at the maturity date. The coupon rate is the interest rate on the bond. A coupon is typically semi-annually. So if the bond has a coupon rate of 8%, the investor will receive two payments per year, each equal to 4% of the bond’s par value.

Rating agencies rate the creditworthiness of bonds. High quality bonds are considered investment grade. Low quality bonds are considered noninvestment grade, or junk bonds.

what is a bond

See Also:
Non-Investment Grade Bonds
Yield to Maturity of a Bond
Zero Coupon Bonds
Sukuk
Baby Bonds

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Zero Coupon Bonds

See Also:
What is a Bond
Non-Investment Grade Bonds
Covenant Definition of a Bond Contract
Yield to Maturity of a Bond
Financial Instruments

Zero Coupon Bonds

Zero coupon bonds are a debt security that does not have periodic interest payments. The bond, issued at a deep discount from par value, compensates for the lack of interest payments. Then they are redeemed at par value at maturity.

Stripped Bond

Banks or dealers create strip bonds, synthetic zero-coupon bonds. Therefore, separate the principal amount (the corpus) from the interest payments (the coupon payments) and sell the two parts separately to investors. Thus, this creates zero-coupon bonds. The investors then receive a lump sum at the maturity date, equal to the value of corpus or the coupon payments, depending on their contract. The contracts are known as STRIPS (Separate Trading of Registered Interest and Principal of Securities).

Imputed Interest

According to the IRS, the holder of a zero-coupon bond owes income tax on the bond’s imputed interest. Imputed interest refers to the implied periodic interest payments that the bondholder does not actually receive until maturity. Imputed interest on zero-coupon bonds issued by municipalities is tax exempt.

zero coupon bonds

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Yield to Maturity of a Bond

See Also:
What is a Bond
Non-Investment Grade Bonds
Covenant Definition of a Bond Contract
Zero Coupon Bonds
Financial Instruments

Yield to Maturity Concept

The yield to maturity (YTM) of a bond represents the annual rate of return for the full life of the bond. The YTM assumes the investor will hold the bond to maturity, and that all interest payments will (hypothetically) be reinvested at the YTM rate.

For example, a bond with a maturity of 10 years and a YTM of 5% implies that buying this bond and holding it for the full ten years would give the investor an annual return of 5% on the invested capital.

Given the bond’s price, par value, maturity date, coupon rate and coupon payment schedule, the YTM represents the time value of money – incorporating the aforementioned variables – that sets the bond price equal to the present value of the future payments of the bond, including coupon payments and principal redemption. The YTM is equal to the bond’s discount rate and internal rate of return.

Define Yield to Maturity

Yield to maturity is the implied annual rate of return on a long-term interest-bearing investment, such as a bond, if the investment is held to maturity and all interest payments are reinvested at the YTM rate.

Current Yield Calculation

The current yield of a bond differs from the yield to maturity. The current yield of a bond represents the implied return on the bond for one year, given the coupon payments and the current market price. For example, if an investor buys a bond for $95 with an annual coupon payment of $5, the current yield for that bond would be 5.26% (.0526 = 5/95). The current yield formula is:

Current Yield = Annual Payment/Current Market Price

Yield to Maturity – Bond Price

If a bond’s yield to maturity is greater than its current yield, the bond is selling at a discount, or a price less than par value. If YTM is less than current yield, the bond is selling at a premium, or a price above the par value. If YTM equals current yield, the bond is selling at par value.

Discount Price – Yield to Maturity > Current Yield

Premium Price – Yield to Maturity < Current Yield

Par Value Price – Yield to Maturity = Current Yield

Bond Yield To Maturity Formula

The formula for a bond’s yield to maturity is complicated and solving it mathematically often requires a process of trial and error. It is possible to get an approximate YTM for a bond using a bond yield table. The best way to compute the YTM for a bond is to use a financial calculator. Using a financial calculator, punching in four out of five of the relevant variables (price, par value, maturity, coupon payment, YTM) will give you the fifth variable.

To calculate the bond’s YTM, solve this formula for YTM:

Price = Coupon Payment x 1/YTM (1 – (1/((1+YTM)^Time Periods)) + Future Value/((1 + YTM)^Time Periods)

 

yield to maturity

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Yield Curves

See Also:
What is a Bond?
Yield to Maturity
Coupon Rate Bond
Par Value of a Bond
Zero Coupon Bonds

Yield Curves Definition

In the field of finance, yield curves represent the relationship between the yields on bonds of similar credit quality that have differing maturity dates. Many commonly use the yield curve plotting U.S. Treasury bonds of differing maturities (3-month, 2-year, 5-year, and 30-year) as a reference for interest rates on other financial instruments. Also, consider the U.S. Treasury bond yield curve an indicator of macroeconomic conditions.

Types of Yield Curves

A yield curve can be normal, flat, or inverted. In a normal yield curve, investments with longer maturities have higher yields than investments with shorter maturities. Whereas, in a flat yield curve, investments with long maturities and investments with short maturities have similar yields. In an inverted yield curve, investments with shorter maturities have higher yields than investments with longer maturities.

Consider a normal yield curve a sign of a healthy economy. However, if long-term yields are significantly higher than short-term yields, it may be a sign of inflation. A flat yield curve is considered a sign of a transitional period in an economy. An inverted yield curve is considered a sign of a troubled economy, or even a recession.

yield curves

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Warrants

See Also:
Common Stock Definition
Purchase Option
Call Option
Put Option
Synthetic Stock

Warrants Definition

The warrants definition is the right to purchase shares or bonds at a fixed price before there is an issuance in the public marketplace. In this sense, a warrant is like a call option. But there are several key differences.

Warrants Explained

Warrants are often used in finance and investing to make a deal better or provide a premium to potential investors in the company. The ability to buy an asset at a fixed price is a huge benefit if the price is higher because an investor can instantly see a profit. Like options, they expire after an allocated amount of time has passed. However, a warrant expiration could be years in the future as opposed to months, which is common for options.

Another large difference between warrants and options is that a warrant grants the right for an investor to buy stock or bonds before they are issued to the public market. This is why many private equity holders contain warrants. If the company has been a successful venture and is ready to issue an IPO, then the private equity holders have the ability to buy stock before the issuance. This right is a huge benefit if an investor sees a company with great potential. As a result, the investor can turn a huge return on investment.

Warrants Example

For example, Wawadoo Co. is a private company that is looking for investors to fund its newly developed product known as the widget. Widgets are considered the future in the market. And Wawadoo believes they will be a huge success. To incentivize private equity holders, Wawadoo has attached stock warrants in relation to the amount of money invested. The warrants have a life of five years. After three years, the widget has been such a success that Wawadoo is ready to enter into the public marketplace by offering an IPO. As this is happening, the private equity group has exercised its warrant. Thus, Wawadoo must honor the warrant. So, they provide the equity group a stake in the newly offered shares in the market before the actual IPO.

Warrants

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Sukuk

Sukuk Definition

A Sukuk is the islamic world’s version of a bond. It is also referred to as an islamic bond. Because Islamic people do not believe in charging or paying interest, they have been forced to maneuver their way around interest by renting certain assets or by taking ownership in a project.

Sukuk Meaning

A Sukuk structure is slightly different, but the principle is the same as a western bond. When a bank invests in a Sukuk or islamic bond, it is considered to be an investment in a certain project or asset that a company is working on. As the project or asset is complete or purchased, the company must then pay the bank rent expense from the cash flows of that asset or project. Overtime, the islamic bond is paid off in rent using fixed payments over a certain amount of time. Then the par value of the the islamic bond is purchased at a future date.

Sukuk Example

For example, Osman is looking to start a new production line in his business that will require the equivalent of $1 million dollars. Because Osman is building this line in Saudi Arabia, he plans on financing the costs using this islamic bond. He then goes and obtains the financing he needs from an islamic bank. The bank invests in the project. They decide that Osman will owe the bank rent of $80,000 per year and the final par value of the Sukuk, ($1 million) 10 years after the project is done. Notice that this is the same set up as a regular bond where the rent expense of $80,000 is equal to an 8% interest rate. And the par value of the bond is due at the end of the term like a bond.

sukuk

See Also:
Coupon Rate Bond
Interest Rate
What is a Bond?
Nominal Interest Rate
Outstanding Debt

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Shanghai Stock Exchange (SSE)

See Also:
Tokyo Stock Exchange (TSE)
National Stock Exchange of India (NSE)
Bombay Stock Exchange (BSE)
Frankfurt Stock Exchange (FSE)
Hong Kong Stock Exchange (HKEX)

Shanghai Stock Exchange (SSE)

The Shanghai Stock Exchange (SSE) is the third largest exchange in terms of market capitalization. The exchange is currently not open to all foreign investors.

Shanghai Stock Exchange (SSE) Meaning

The Shanghai Stock Exchange was formed in the 1842 as one of the first to be established in Asia and the first in China. The SSE Exchange trades in bonds, funds, and two classes of stock. The two types of stock are the Class A and Class B stock. At first the Class A stock was limited to Chinese Investors while the Class B remained open to all investors. However, after reforms the SSE changed its format slightly allowing a few foreign investors to invest in the Class A stock with several limitations. The class B stock remained open to all foreign and domestic investors after the reformation. The Class A stock is also currently listed with the local Yuan currency while Class B is listed under the U.S. dollar. The SSE exchange main indexes are the SSE 180 index and the SSE 50.

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shanghai stock exchange (sse)

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