Bond: Fixed income security "loan" to the government

• Maturity >1 year
• Holder receives: periodic payments (coupons) + lump sum (face value) at maturity
• Bonds can be sold to another investor
  • So the orig. holder can get his money back early unlike loans
  • Also the only justification for buying bonds with NEGATIVE YIELD; in hopes that the security will rise in price somehow??
• $Yield \propto -Bond\text{ }Price$
  • Bond interest rate (yield) is determined by bond mark demand; more demand = higher yield
  • When yields increase, it indicates the bond market is in bad condition
  • Less buyers ⇒ price down, yield up ⇒ more buyers ⇒ price up, yield down ⇒ repeat

Zero Coupon Bond: No coupons, only face value

Yield to Maturity: Effective rate of return based on current market value; when the bond is first issued, YTM == Coupon Rate

• YTM based on current mkt. value of bond, Coupon Rate based on face value (when it was issued) of bond

Expectation Theory: Long-term bond yields = geometric avg. of expected intermediate bond yields

Maturity Preference Theory: Investors prefer short maturities, so long-term bonds must compensate with higher yields

Yield Curve: Plot of Time to Maturity (x) against Expected Yield (y)

• Inverted Yield Curve: Downward-sloping yield curve

Inflation: "Wedge" between real and nominal/observed/spot rate

• Relationship found using the Fisher Equation
• Estimated using CPI: fixed basket of goods & services in current year vs. base year

Default: Investee can't pay back; their rating goes down

• Government bonds have no risk
• High default risk compensated by having lower prices and higher yields

Five factors that affect yield to maturity

Conventions for dealing with defaults