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Sem 5 Prep
← Money & BankingBonds and the Indian bond market

Formulas for this chapter

Current yield

Current yield = Annual coupon payment / Current market price x 100

When you want the cash return at today's price. It ignores the pull back to par, so it is not comparable across premium and discount bonds.

Annual coupon payment
Coupon rate x par value, in rupees
Current market price
Traded price, which may be above or below par

Premium, par and discount rule

YTM > Coupon rate -> discount (price < par) YTM = Coupon rate -> par YTM < Coupon rate -> premium (price > par)

To place a bond without doing any present-value arithmetic. Works in both directions: from price to yield, or from yield to price.

YTM
Yield to maturity, the market's required return
Coupon rate
Contractual rate on par value

Clean and dirty price

Dirty (invoice) price = Clean price + Accrued interest Clean price = Dirty price - Accrued interest

Any trade between coupon dates. Quotes are clean; the money that changes hands is dirty.

Accrued interest
Coupon earned by the seller since the last coupon date but not yet paid

Capital indexed bond

Indexed principal = Par x (1 + index rate)^n Coupon paid = Fixed coupon rate x Indexed principal

Prof. Panda's sixth bond type. The rate is fixed, the principal moves, so both the coupon and the redemption amount rise with inflation.

index rate
Annual movement of the inflation index
n
Number of years the principal has been indexed
Step 2 of 25
The real wordsTheory

The professor's overview

His own four lines, and they are worth quoting.

  • Bonds are long-term fixed income securities
  • Both the cash flow streams (interest and principal) and the time horizon (maturity) are well specified and fixed
  • This makes bond valuation easier than stock valuation
  • It is less glamorous for two reasons: returns from bonds are less impressive and fixed, and bond prices fluctuate less than equity prices

Because the cash flows are more certain, the emphasis is on fine-tuned calculation, and an investor in bonds looks out for even small differentials in prices and returns.

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