Bonds

Monetary vs. Fiscal Policy

• Monetary policy is managed by central banks, aiming to control inflation, stabilize currency, and support employment.
• Fiscal policy is controlled by governments, with the goal of influencing economic growth.
• Fiscal policy uses adjustments in spending and taxes to achieve these goals.

Bonds

• Definition: Fixed-income investments where investors lend money to entities (governments or corporations).
• Purpose: Entities use bonds to raise capital for various projects, operations, or to refinance debt.
• Structure: Bonds typically feature a fixed interest rate (coupon) and a fixed term/maturity date when the principal is repaid.
• Types:
  • Government Bonds: Issued by federal governments for national projects, low risk, lower yields.
  • Corporate Bonds: Issued by companies, higher risk, higher yields.
  • Municipal Bonds: Issued by local governments, often tax-free, for community projects.
  • International Bonds: Issued by foreign countries/corporations, include currency risk.

Bond Pricing

• Bond price is the present value of future coupon payments plus the present value of the principal payment.
• Yield to Maturity (YTM): Total return if the bond is held until maturity, accounting for all payments and price.
• Yield to Call (YTC): Return if the bond is called before maturity.
• Price-yield relationship: Bond prices fall as yields rise, and vice versa.

Yields

• Definition: Returns an investor earns from a bond.
• Current Yield: Annual interest payment divided by the current bond price.
• Yield to Maturity (YTM): Total return if the bond is held to maturity.
• Yield to Call (YTC): Return if the bond is called before maturity.

Coupon Rate

• Definition: Fixed interest rate that is paid annually, expressed as a percentage of the bond's face value.
• Types: Fixed rate (constant payment), and floating rate (variable payment tied to a benchmark interest rate).

Bond Rating

• Purpose: Assess credit quality and risk of default.
• Rating agencies: Moody's, Standard & Poor's, Fitch.
• Categories: Investment grade (low risk), and High Yield/Junk Bonds (higher risk).

Interest Rate Risk

• Definition: Risk that bond prices will fall as interest rates rise.
• Impact: Long-term bonds are more sensitive to interest rate changes than short-term bonds.
• Mitigation: Choose shorter duration bonds or floating-rate bonds.

Credit Risk

• Definition: The risk that the bond issuer will default on its payment.
• Factors: Issuer financial health, economic conditions, industry outlook.

Duration

• Definition: Measures a bond's price sensitivity to interest rate changes.
• Calculation: Weighted average time to receive all cash flows.
• Duration and interest rates: Higher duration, higher sensitivity to rate changes.

Convexity

• Definition: Describes how duration changes as interest rates change.
• Purpose: Provides a more accurate measure of interest rate sensitivity beyond what duration predicts.
• Importance: Offers greater price stability.

Callable & Convertible Bonds

• Callable Bonds: Bonds that can be repaid early before their due date.
• Convertible Bonds: Bonds that can be converted into stock of the issuing company.

Bond Valuation & Market Dynamics

• Market Influences: Bond prices fluctuate due to changes in interest rates, inflation expectations, credit ratings, and supply/demand dynamics.
• Valuation Drivers: Lower interest rates, higher economic outlook, or issuer stability increase bond prices.