FAQ - Fixed Income Instrument
Q. What is a bond?
A. A bond represents a contract under which a borrower promises to repay interest and principal on specific dates to holders of the bond.
Q. Who can issue bonds?
A. Bonds are issued by a variety of organizations. The principal issuers of bonds in India are the central government, state governments, public sector undertakings, and private sector companies. Bonds issued by the central government are called Treasury Bonds.
Q. What is par value?
A. Par value is the value stated on the face of the bond. It represents the amount the firm borrows and promises to repay at the time of maturity.
Q. What is Coupon Rate?
A. A bond carries a specific interest rate which is called the coupon rate. The coupon is the amount the bondholder will receive as interest payments.
Q. What is Maturity Date?
A. The maturity date is the date in the future on which the investor's principal will be repaid.
Q. What is Yield?
A. Yield is the return you get on a bond.
Q. What is Current Yield?
A. Current Yield relates the annual coupon interest to the market price. It does not consider the capital gain (or loss) that an investor will realize if the bond is purchased at a discount (or premium) and held till maturity.
Current yield is calculated by dividing the annual interest by the market price of the bond.
Q. What is Yield to Maturity?
A. Yield to Maturity (YTM) is the rate of return you will earn if you buy the bond and hold it to maturity. YTM considers the current coupon income as well as the capital gain or loss the investor will realize by holding the bond to maturity.
Q. What is the relationship between the price of the bond and yield?
A. A basic property of the bond is that its price varies inversely with the yield. They behave like two sides of a see-saw. This is because, as the yield decreases, the present value of the cash flows increases, hence the price increases. Conversely, when the yield increases, the present value of the cash flow decreases.
Q. What is Duration?
A. Duration is a measurement of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows. It is a measure of the sensitivity of the asset's price to interest rate movements. Bonds with high Duration factors experience greater increases in value when rates decline, and greater losses in value when rates increase, compared to bonds with lower duration.
Q. What is Modified Duration?
A. Modified Duration is a measure of the price sensitivity of a bond to interest rate movements. Modified duration follows the concept that interest rates and bond prices move in opposite directions. This formula is used to determine the effect that a 100-basis-point (1%) change in interest rates will have on the price of a bond.
Q. What is the benchmark in bond market?
A. The benchmark in bond market is the 10 year Government Security offering a coupon rate of 7.8% p.a. with maturity due in 2021.