INTRODUCTION TO BONDS
Bonds are the basic ingredient of the world’s debt-capital markets, which in turn are the cornerstone of the world’s economy. Consider how many television news programmes contain a slot during which the newscaster informs viewers where the main stock market indexes closed that day and where key foreign exchange rates ended up. More usefully, the financial sections of most newspapers also indicate at what yield the government long bond closed. This coverage reflects the fact that bond prices are affected directly by economic and political events, and yield levels on certain government bonds are fundamental economic indicators. The yield level on the US Treasury long bond, for instance, mirrors the market’s view on US interest rates, inflation, public-sector debt, and economic growth.
The media report the bond yield level because it is so important to the country’s economy - as important as the level of the equity market and more relevant as an indicator of the health and direction of the economy. Because of the size and crucial nature of the debt markets, a large number of market participants, ranging from bond issuers to bond investors and associated intermediaries are interested in analysing them. This chapter introduces the building blocks of the analysis.
Bonds are debt instruments that represent cash flows payable during a specified time period. They are a form of debt, much like how a bank loan is a form of debt. The cash flows they represent ...