Saturday, 22 May 2010

All about Bond

Bond is a debt security which is issued by Government or Corporations and participants buy and sell them in the bond financial market.

Bond is considered as a low-return safe investment but it's certainly better than saving your money in a normal current bank account.

Bonds are often called "fixed-income securities".

Issuer of a Bond:
The organization or Government which issues the Bond. The issuer borrows the money and promises to pay it back at the maturity date and with a yearly interest rate.
  • U.S. government
  • Government agencies
  • Companies
  • Cities

Why Bonds are Issued?
Issuing bonds is a way to raise money for e.g. governments to build facilities, bridges, etc.

Nominal Value of a Bond (par value, face value or the principle):
The original price of a Bond e.g. £100. That's what you get on the maturity date.

Interest Rate of a Bond:
The yearly interest rate that a Bond pays to its buyer such as 5%. This is a fixed rate and is calculated based on the Nominal Value not based on the Current Value.

Bonds never return an exciting amount and are not like Stocks. In average they return 5%.

Interest rate types:
  • Fixed
  • Floating
  • zero-coupon bonds
Maturity Date:
The date on which the bond issuer must repay the capital borrowed. It can range from days to years.

Redemption Date of a Bond:
The date on which a bond matures or is redeemed e.g. 1 Jan 2011.

Current Price of a Bond:
Price of a Bond changes over time and doesn't stay as the same as its Nominal Value (original value). The price might drop or rise over time. So a Bond with the par value of £100 might have the current value of £95.

Nominal Yield of a Bond:
This is calculated by dividing the annual income on the bond by its nominal value. So the nominal yield on a £100 bond which pays 5% interest per year is 5/100 x 100 = 5%

A higher Nominal Yield is better than a lower one.

Current Yield of a Bond (running yield):
This is calculated by dividing the annual income on the bond by its current market price. So if the market price of the £100 bond dropped to £95, the current yield on the bond at that time would be 5/95 x 100 = 5.36%. Note that as the market price of a bond drops, its yield goes up.

Current Yield is variable over time.

Redemption Yield of a Bond:
The Redemption Yield shows what the total return on a bond would be if held to its maturity date.

It reflects not only the interest payments a bondholder will receive, but also the gain/loss he will make when it matures.

The income element is the same 'current yield' calculation performed above. The gain/loss element is calculated by taking the difference between the current market price and the nominal value of the bond (e.g. in our example 100 - 95 = 5), dividing it by the number of years til maturity (assume 5 years for simplicity, so 5/5 = 1) and then dividing that figure by the current price of the bond (1/95 x 100 = 1.05%) The yield to redemption is the sum of the current yield (5.36%) and the capital yield (1.05%) = 6.41%.

Bonds Benefits
  • Stable and predictable; unlike stocks - A Bond price doesn't go up and down like Stocks
  • On the maturity date you will get the capital back + all the interests you have already received
  • You can sell your Bonds to other investors which means you can raise cash if you need to
Bond Screening Tools?
The tools provided by companies and website to screen the bond prices using which you can buy bonds online.

Why market price of a Bond changes?



Sunday, 9 May 2010

Understanding Compound Interest

Compound interest can be calculated with the following formula:

FV = PV (1 + i)^N

FV = Future Value (the amount you will have in the future)

PV = Present Value (the amount you have today)

i = Interest (your rate of return or interest rate earned)

N = Number of Years (the length of time you invest)


Assume you have £1000 and you want to invest it for 10 years. You found an investment with 10% return, so after this period what will you have? £1000*((1+ 10%)^10) almost £2,600

If the interest was 0.05%, then after 10 years you would have almost £1,630.

So, in the former example you would have £1600 interest whereas in the later only £630 which is slightly above third of the former although the later interest rate was only half of the former.

Regular Saving

Now, imagine you'd save £1000 every year for 10 years and each year the interest rate would be 10%.

How much will you have at the end of the 10 years?