User FAQs

1) What is a Bond ?
The term bond refers to a loan which typically has a fixed rate of interest (the coupon rate). The most common types of bonds are those issued by governments (treasuries and gilts).

2) Can you describe the bond market ?

3) What are the main differences between Equities and Bonds ?

4) Why would someone buy a bond ?
To invest their money into a particular company or government and to receive regular fixed interest payments.
The longer the term the better the interest rate
When the bond reaches the maturity date the principal amount is returned.

5) How do you price a bond ?
The price is the Net Present Value of all the future cash flows.
Principal - the amount that will be paid when the bond matures.
Coupon Rate - the rate of interest paid. (either annually or semi-annually)
Maturity Date - the date the principal will be paid back.
Interest Rate - (risk free) the discount rate to use (typically spot rate)

6) What affects the price of a bond ?
Interest Rates - when interest rates increase, the price decreases
Inflation - when inflation increases, the price decreases
Credit Rating - when the rating increases, the price increases

7) Can you describe the price/yield relationship for bonds ?

8) How would you explain the Credit Spread ?

9) What is a Basis Point ?
A basis point means 1/100 of a percentage.
eg - 2.0 + 10 basis points is 2.1%
eg - 2.0 + 50 basis points is 2.5%

10) What is a Government Bond ?
Also known as Sovereign Debt
US - called Treasuries
UK - called Gilts
Germany - called Bunds

11) Can you describe a Treasury Bill ?
These are zero coupon bonds issued by the US for terms of up to 12 months.
They are sold at a discount.

12) Can you give the names of the different types of US government bonds ?
Bills - issued for terms of 1, 3, 6 and 12 months (Zero Coupon Bonds, sold at discount)
Notes - issued for terms of 2, 3, 5 and 10 years
Bonds - issued for terms of 30 years

13) What is the Yield To Maturity ?
Also known as Bond Yield
The yield to maturity of a bond is the total return from all the cash flows when you hold the bond to maturity.

14) How do you calculate the Yield To Maturity of a bond ?
In Excel you can use a number of different worksheet functions including the iterative Goal Seek approach.
yield = (coupon rate / bond price) ?

15) Can you describe what a Spot Rate is ?
A spot rate is the yield to maturity on a zero coupon bond.
It is therefore equivalent to the discount rate that converts the par values to its present value.
This can be calculated from a Forward Rate.

16) Can you describe the term Yield Curve ?
This is the yield to maturity on "Coupon Bonds" with similar credit ratings.
A yield curve that is constructed using US government securities, is called the treasury yield curve.
A yield curve that is constructed using UK government securities (glits) is called the gilts yield curve.

17) What is the Zero Coupon Curve ?
Also known as the spot curve.
This is the plot of simply compounded interest rates up to one year and of annually compounded interest rates for longer than one year.
This is obtained by using on-the-run US Treasury securities, off-the-run US Treasury securities or a combination of both or US Treasury coupon strips.
The instruments you use should not have any credit risk, liquidity risk or any pricing anomalies.

18) Can you describe Duration ?
This is a measurement of how sensitive a bond is to changes in interest rates.
The first derivative of the price with respect to interest rates.

19) Can you describe Convexity ?
This is a measurement of how quickly the duration is changing.
The second order derivative of the price with respect to interest rates.

20) Can you describe a Callable Bonds Convexity ?

21) What is the DV01 ?
How much an asset moves when the interest rate moves by 1 basis point.

22) Can you give the names of the different types of german government bonds ?
Schatz - less than 2 years
Bobl - 3 - 5 years
Bund - 10 - 30 years

23) What is a Domestic Bond ?
A bond denominated in the currency of the country in which it was issued.
A UK corporate bond trading in the UK, denominated in sterling.

24) What is a Foreign Bond ?
A bond trading in a different country and denominated in a different currency.
A UK corporate bond trading in the US, denominated in dollars.

25) What is a Eurobond ?
A bond trading in a different country and denominated in its local currency.
A UK corporate bond trading outside the UK, denominated in sterling.

26) What is a Global Bond ?
A bond trading in multiple countries and denominated in the corresponding local currencies.
A UK corporate bond trading in the US, deniminated in dollars and also trading in Japan, denominated in yen.

27) What is a Junk Bond ?
A junk bond is any bond that is not investment grade, which has a rating of BB or lower.
Also known as high yield

28) What is a Zero Rated Bond ?
Also called a zero coupon bond.
This is a bond that has no coupon and is therefore issued at a discount to its face value.

29) What is a Subordinated Bond ?
These have lower priority than other bonds in the event if liquidation.
They have a lower credit rating and higher risk.

30) What is a Convertible Bond ?
This is a type of bond that can be converted into equity at a later date, usually at a premium to the market value. They typically carry a low coupon rate and are usually less volatile that regular shares.
Can be converted into shares at some pre-announced ratio
Investors can obtain the upside of equity like returns while being protected with regular bond like coupons

31) What is the difference between Nominal Yield and Real Yield ?
Nominal Yield is the coupon rate or coupon yield.
Real Yield takes inflation into account.

32) What is the Nominal Spread for a Corporate Bond ?
Also known as the yield to maturity spread.
It is the difference (in basis points) between the yield to maturity of the Corporate Bond and the yield to maturity of a Government Bond with the same characteristics.
This indicates the credit risk associated with the Corporate Bond.
It provides a very simple way of comparing 2 bonds with the same maturity.
This only uses one point on the curve.

33) What is the Z-Spread for a Corporate Bond ?
Also known as the zero volatility spread.
It is the constant amount (in basis points) that needs to be added to all the different spot rates for the present value to equal the bond price.
Each cashflow is discounted at the appropriate spot rate plus the z-spread.
This uses the whole curve and is calculated using an iterative approach.

34) What is a Floating Rate Note ?
This is a bond that has a variable coupon that is paid quarterly.
They are linked to a money market reference rate, such as LIBOR plus a spread.
For example a coupon might be 3 months USD LIBOR +0.1%

35) Can you describe a Government Bond Future ?
Also known as long term interest rate futures.
These allow traders to gain exposure to the underlying asset as well as allowing them to hedge the risks associated with these assets.
These require actual physical delivery when settled.
US Treasury Bond 30 year - contract size is $100,000, coupon 6%
US Treasury Note 10 year
US Treasury Note 5 year
US Treasury Note 2 year
US Treasury Bill 90 day
Euro/German Bund - contract size EUR100,000
Euro/German BOBL - contract size EUR100,000
Euro/German Schatz - contract size EUR100,000

36) Why would someone buy a Bond Call Option ?
They are expecting a decline in interest rates and an increase in bond prices.

37) What is a Bond Return Swap ?
An agreement between two parties to swap a fixed rate based on LIBOR with the total return from a bond (coupons).