Bond: A written legal contract that is a promise to repay with interest; issued by a
corporation, government or government agency.
Coupon payment: Savers buy these bonds and, in most cases, get paid interest in
return
...
Bond: A written legal contract that is a promise to repay with interest; issued by a
corporation, government or government agency.
Coupon payment: Savers buy these bonds and, in most cases, get paid interest in
return —usually every six months.
Coupon rate: The stated rate of interest that will be paid to the holder of the bond.
Face value (of a bond): The original amount of money borrowed by a bond issuer. This is
also sometimes called the bond principal.
Secondary bond market: The market for bonds or other debt instruments that were
previously issued.
Rate of Return = Amount get back / Amount put in
Market price of a bond: The present value of the cash flow the owner of the bond can
expect to receive over the life of the bond.
PBOND = PVBOND =
C 1
(1+k)1 +
C 2
(1+k)2 +…+
Cn+Face
(1+k)n
Par: Market price of a bond equals the face value of the bond. (when the market interest
rate equals the bond’s coupon rate)
Discount: When the market price is below the face value. (when the market interest rate
above the bond’s coupon rate) below par
Premium: When the market price of a bond is above the face value. (when the market
interest rate below the bond’s coupon rate) above par
Change in supply versus change in quantity supplied: Change in supply is a change in the
price and quantity relationship from a seller’s perspective, whereas a change in quantity
supplied comes about from a change in the price of the good or service.
Change in demand versus change in quantity demanded: Change in demand is a change in
the price and quantity relationship from a buyer’s perspective, whereas a change in
quantity demanded comes about from a change in the price of the good or service.Primary market: The initial sale of a bond.
As the price of bonds increases, or their yields decrease, these issuers will want to
issue more bonds because the yield, or the interest rate the issuers have to pay to
bondholders, the borrowing costs of bond issuers decline.
Thus, in the primary market, as the bond prices increase, the quantity of bonds
in demand increases; that is, the supply curve of bonds slopes upward.
Secondary bond market: The market for bonds or other debt instruments preciously
issued.
As the price of bonds increases in the secondary market, we have an increase in
the quantity supplied of bonds.
The Supply for Bonds
1. Business Expectations
If businesspeople become more optimistic about the future, they will want
to borrow more money to expand their output.
2. Expected Inflation
If you think there will be inflation in the future, you want to borrow more
now.Inflation reduces the real cost of debt
Real cost of debt: The burden of debt measured in constant terms.
3. Government Deficits
4. Investment Tax Credits
To get this tax credit, imagine the consumer goods producer has to spend
$60 million to expand its headquarters. So, to get the $5 million tax credit,
Kimberly-Clark has to spend $60 million. Where will Kimberly-Clark get
that $60 million? It will most likely issue bonds.
The Demand for Bonds
1. Wealth
2. Expected Relative Returns to Bonds
3. Relative Riskiness of Bonds
Default risk: The risk that a borrower will not pay interest or principal as
promised.
4. Liquidity of Bonds
Liquidity: The ease and expense at which one asset can be converted into
another asset.5. Information Costs
Equilibrium in the Bond Market (Surplus & Shortage)
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