Abstract
This Chapter defines various parameters of bonds like coupon, maturity, par value, ownership type and indentures. Types of bonds differentiated by the type of collateral behind the issue are introduced. Bond returns and valuations are derived heuristically based on the return concept defined in the previous Chapter. Fundamental determinants of interest rates and bond yields, together with the Macaulay duration are discussed with examples. The yield curve is presented together with its implications for the economy.
The United States can pay any debt it has because we can always
print money to do that. So, there is zero probability of default.
— Alan Greenspan
An investment in knowledge pays the best interest.
— Benjamin Franklin
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Notes
- 1.
LIBOR (London Inter Bank Offered Rate) is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks. It is the primary benchmark, along with the Euribor, for short term interest rates around the world.
- 2.
Tier 1 capital is the core measure of a bank’s financial strength from a regulator’s point of view. It is composed of common stock and disclosed reserves (or retained earnings), but may also include non-redeemable, non-cumulative preferred stock [10].
- 3.
Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action.
- 4.
Caveat emptor: many inexperienced investors make their investment decisions by just looking at the coupon of a bond and forgetting to look at its price or call date.
- 5.
The analytical solution of such quartic equations was published already in 1545 by Gerolamo Cardano in his book Ars Magna. The general solution of a quartic equation, requiring the solution of a cubic equation (also credited to Cardano), is so unwieldy that it is seldom used, if at all.
- 6.
There are several different definitions of durations which are known under the names modified duration, effective duration, key-rate duration or Macaulay duration . This Book uses only the Macaulay duration.
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Hacιsalihzade, S.S. (2018). Bonds. In: Control Engineering and Finance. Lecture Notes in Control and Information Sciences, vol 467. Springer, Cham. https://doi.org/10.1007/978-3-319-64492-9_7
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DOI: https://doi.org/10.1007/978-3-319-64492-9_7
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