Question

 

1. a) What is a bond ? Create an example.

              What are the traditional categories of bond issuers?

    b) Describe the primary market for (many) bonds.

             What is underwriting ?

    c) What (where) is the secondary market for bonds ?

              Describe a transaction in this market for bonds.

    d) What is yield ? Give an example, demonstrating yield versus

             coupon rate.

Answer 1

Answer1) A bond is a debt instrument which represents a loan made to the organisation by the investor. It’s a type contract or loan where interest rate, Par value i.e price of an instrument, payment frequency, tenor of bond is mentioned. Orgnisation such as municpal coporations and corporates issue bond to fund their growth activity. Here, the one who is issuing a bond is borrower and the investor who is investing in the bond is lender.

Example: Apple had issued bonds worth $3 billion with par value of $1000 at 3.85% coupon rate with maturity of 30 years in which copon is paid semiannually

Categories of bond issuers: Public companies, municipalities, states governments, and sovereign governments are the categories of the bond issuers. The funds raied by these issuers are used to finance their projects and operations.

Answer 2)

Primary Market for the bond is where bonds are issue for the first time for the bond investors bu the issuer. Major exchanges act as a primary market for many corporate bonds

Underwriting is the process in which an investment bank helps the issuer to issue the new securoty such as Equity, Bonds etc, in return investment banks charge fees to these issuers

Answer 3)

Secondary market for the bond is the market place where the bond is traded which are already issued in the primary market. Secondary market can be available for investors on exchanges or Over The Counter (OTC) Market.

The transation happen in the secondary market with other Investors who are ready to buy the bonds from the investors in the primary market

Answer4)

A bond's yield - It is the return to an investor from the bond's coupon and maturity cash flows.

It can be calculated as coupon rate divided by changes in the bond's price which is being traded in the secondary market.

Lets take the above example of Apple Bond, which has coupon rate of 3.85% on $1000 bond.

Coupon Payment = $38.5 per annum on above bond

Now, if above bond is trading at $975 in the secondary market then yield can be calculated as coupon payment/ Bond Price

Currnet Yield = Coupun Payment/ Bond Price

Currnet Yield = 38.5/975

Current Yield = 3.95%

One can observe yield has been increase from earlier coupon rate as the price of the bond falls.

Hence, one can conclude that Price of the bond is inversaly proportional to yield.