Bond Returns
Bond returns refer to the profit or loss an investor realizes from holding a bond over a specific period. They are influenced by factors such as the bond's coupon rate, market interest rates, and the bond's price fluctuations. Bond returns can be calculated as the sum of interest payments received and any capital gains or losses upon the bond's sale.
7 Key excerpts on "Bond Returns"
eBook - ePub- Ian Davidson, Mark Tippett(Authors)
- 2012(Publication Date)
- Routledge(Publisher)
...1 The measurement of returns on bonds, equities and other financial instruments §1-1. The calculation and indeed, the manipulation of returns pervades our everyday lives. When one opens a bank account or line of credit with a financial institution, the rate of interest on surplus funds and/or the rate of interest on the overdraft facilities we expect to use figure highly in the decisions we make about which bank/and or financial institution we will lend our custom to. When it comes to risky assets such as the shares and bonds of publicly listed companies, we make investment decisions by weighing the returns we expect to get from our proposed investments against the risks that are likely to arise from them. Our retirement plans also hinge crucially on the returns earned by the superannuation funds with which we deposit our retirement funds and on the prospective benefits these returns will enable us to enjoy after we retire. All of this presupposes of course that we have a clear understanding of how the returns on a given portfolio or financial instrument ought to be calculated. Hence, the principal brief of this chapter is to identify the pitfalls that may arise from the incorrect calculation and averaging of the returns that accrue on shares, bonds, portfolios and other financial instruments. We begin our analysis with a consideration of the procedures that can be used to compute the returns on bonds. §1-2. A bond is a written contract by a debtor to pay a creditor a redemption payment V on an indicated date and to pay a pre-specified amount K (normally termed interest) on a periodic basis. The typical bond mentions a borrowed principal H, called the face value or par value of the bond. Bonds typically make interest payments on a semi-annual basis and are redeemable at par – in which case V = H. Consider, then, the purchaser of a bond who demands that his money be invested at a pre-specified rate r. We call this the investment rate...
eBook - ePubDemystifying Fixed Income Analytics
A Practical Guide
- Kedar Nath Mukherjee(Author)
- 2020(Publication Date)
- Routledge India(Publisher)
...4 Risk and return measures Key learning outcomes This chapter is expected to enable readers to answer the following questions: What are the different types of risk associated with investment in fixed income securities? How to capture risks in individual debt security and the portfolio. What are the different measures to calculate returns from investment in debt instruments? How to estimate security-wise and portfolio level returns. What are the major advantages and limitations of various risk-return measures? Risk and return in bonds: meaning and linkages Bonds are an important component of investment portfolios for most investors, especially for institutional investors. Bonds reduce the overall risk of a portfolio by introducing diversity. Bonds produce steady current income – income that investors receive, say in every year/six months/quarter. This steady stream of income is important to some investors, depending on their asset-liability structure and their current needs. Bonds are more low-risk investments than stocks, sometimes at the cost of lower returns. The attractiveness of bond investment largely depends upon the future movement of interest rates. Bonds are attractive options when the market anticipates interest rates to fall. As interest rates fall, bond values rise, giving a positive return to the investor. The main sources of return from a bond are: regular (annual/semi-annual) coupon income, reinvestment income (i.e. interest on coupon received), and bond’s price appreciation (if any). Even if the coupon rate, the major source of return from a bond, is fixed in a fixed rate bond, there may be several risk factors causing different levels of variation in the returns from a bond. Alternatively, bonds are susceptible to a number of risks, depending on the nature of the bond issue. Like other investment opportunities in the financial market, the risk-return linkage is also applicable in a bond investment...
- H. Kent Baker, John R. Nofsinger, Andrew C. Spieler(Authors)
- 2020(Publication Date)
- Emerald Publishing Limited(Publisher)
...Alternatively, investors can submit noncompetitive bids and accept the rate determined at the auction. After issuance, these bonds trade in secondary markets where smaller investors can buy them. In contrast, an investment bank helps corporations issue bonds. The investment bank helps line up buyers in the premarket and receives a fee for its services. Individual investors can buy the bonds in the secondary market through a broker or online trading platform. Many individuals buy bonds indirectly through a mutual fund or ETF. These structures provide liquidity and diversification to the investor. The investor has a claim to a fraction of many bonds based on a proportionate share of the underlying bond pool. Fees are associated with mutual funds and ETFs, but the ease of buying and selling far outweighs these costs for small investors. 3.11. HOW DO YOU MEASURE A BOND INVESTMENT’S RETURN? Measuring a bond’s return can be tricky because the investor periodically receives fixed coupons and a bond’s price changes almost every day. Additionally, a bond is a multi-period investment because it pays interest payments every six months, but it’s customary to report returns on an annual basis. Two common measures of Bond Returns are current yield and yield to maturity (YTM). Current yield is the annual coupon divided by the bond’s price, which represents the short-term percentage return on the investment. For example, if an investor purchased a bond for $980 with annual coupon rate of 6%, the current yield would be $60/$980 = 6.1%. Savvy investors recognize that a bond’s price can change daily but approaches par value by maturity, so it’s not the most accurate measure. That is, the current yield in each year can change. “It all comes down to interest rates. As an investor, all you’re doing is putting up a lump-sum payment for a future cash flow.” Ray Dalio The YTM is a more common method...
eBook - ePubThe Pillars of Finance
The Misalignment of Finance Theory and Investment Practice
- G. Fraser-Sampson(Author)
- 2014(Publication Date)
- Palgrave Macmillan(Publisher)
...In practice, this view gives rise to a belief that there is some sort of direct relationship between ‘volatility as risk’ and return, and that higher levels of return can only be sought out by accepting higher levels of ‘risk’. We have seen that, with the significant exception of bonds, periodic return measures are in universal use, while compound measures such as IRRs are ignored. That this should be so seems curious, given that IRRs reflect real life investor mind-sets, take account of the time value of money, and allow full comparison of all asset types against each other, whereas periodic returns do none of these things. It seems that we have some understanding of what return is in general, but it is less clear that in practice we understand the precise nature of periodic return, the differences between periodic and compound return, or the reasons for choosing one over the other. Bonds As we have seen, bonds are essentially loan notes, paying back an agreed capital sum (‘redemption’) when the loan period comes to an end (‘maturity’) and making agreed interest payments (‘coupon’) in the meantime. Rather curiously, they are viewed by Finance World in a way which is completely different from the treatment which they accord to equities (shares). Even more curiously, this obvious anomaly has never been justified, and is frequently overlooked. Bonds generate a stream of cashflows: coupon payments and a final redemption payment. Shares offer a stream of cashflows: dividend payments and a final distribution on the winding up of the company either through insolvency or because its business has been discontinued...
eBook - ePubPortfolio Design
A Modern Approach to Asset Allocation
- Richard C. Marston(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...Recall that Bond Returns consist of a coupon plus a capital gain. In periods of rising inflation, there will be sustained capital losses on bonds as yields rise to reflect inflation. This is what we experienced in the 1970s. In periods of falling inflation, such as in the 1980s and 1990s, there will be sustained capital gains on bonds as yields fall. But unless inflation has a long-run trend to it, the capital gain element of the bond return should be close to zero in the long run. Indeed, since 1951, the capital gain component of the long-run bond return has been slightly negative at −0.4 percent. On the basis of this historical record, how might we form expectations of future Bond Returns? Forecasts of Bond Returns in the short run are best left to Wall Street experts. They have about a 50 percent chance of being right in forecasting whether interest rates will rise or fall. Forecasts for the longer run ought to be informed by this long historical record. If real Bond Returns since 1926 have averaged around 2 percent to 2.5 percent, this seems like a prudent forecast for the future. The last 25 years were a great period to be an investor in bonds. But remember that these returns simply reversed the disastrous losses of the preceding decades. RECONSIDERING STOCK RETURNS The collapse of equity prices beginning in 2000 has led many investors to revise their estimates of long-run equity returns. In place of the optimistic estimates of high double-digit returns so characteristic of the late 1990s, some investors now envisage returns on equity equal to or even below those on fixed income. 11 If equity returns are this low in the future, there will have to be major revisions of long-run investment plans. Endowments and foundations will have to adopt significantly lower spending rules, and corporate pension funds will face increased funding costs...
eBook - ePub- Robert Irons(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...5 Bonds and Bond Valuation In Chapter 4, we discussed the structure of interest rates and how they are determined, as well as the relationship between short-term and long-term interest rates. In this chapter, we will see how debt is used to fund a firm’s operations or its investments, and how changes in market interest rates affect the market value of the firm’s debt. The material in this chapter shows clearly the impact of the fundamental principles and precepts in determining the value of bonds in the market. A solid understanding of these connections will help you intuit the expected changes to a bond’s value in the face of changes to its cash flows, its level of risk or its discount rate. The Fundamental Principles in Action FP1 states that an asset derives its value from the cash flows it will produce. Bonds have very specific cash flows—interest payments and the return of the principal—and those cash flows are the basis of the model used to value bonds. FP3 indicates the inverse relationship between an asset’s yield and its market value. This is clearly reflected in the mechanics of bond valuation—increases in market interest rates negatively impact bonds’ market values. FP2 asserts that risk and return are directly related, and so riskier assets require higher returns. This applies to bonds as well, and it can be seen in PR1 (relating value inversely to the discount rate). Since the market interest rate is used as the discount rate in valuing bonds, bonds of higher risk will pay a higher discount rate, which will reduce the market value of the bonds. The Basics of Bonds A bond is a debt instrument; a loan reinforced by a detailed contract. The issuer of the bond agrees to repay the debt in full on a certain date and to make regular interest payments until that date (assuming the life of the debt is more than one year)...
eBook - ePubThe Permanent Portfolio
Harry Browne's Long-Term Investment Strategy
- Craig Rowland, J. M. Lawson(Authors)
- 2012(Publication Date)
- Wiley(Publisher)
...Chapter 7 Bonds Bonds for Safety and Income During periods of prosperity when the economy is healthy and expanding, bonds provide a steady stream of income while also dampening the volatility of the stock market. There are, however, periods when the entire economy goes through a period of deflation, serious financial crisis, or some combination of destabilizing events. It is during these periods that bonds can be one of the few assets that actually go up in value. A bond is a loan. The borrower makes periodic interest payments over a certain amount of time before returning the initial loan to the lender. Just like risks of a loan you'd make for someone to buy a car or a home, a bond also has risks that affect whether or not it will be repaid and how it will be repaid. The bond market is probably one of the most complex pieces of the investing world to understand. The main problem is that there are many types of bonds and many types of overt or very subtle risks in bonds. For reasons that will become clear, the only bonds that are appropriate for the Permanent Portfolio are 25- to 30-year U.S. Treasury long-term bonds. These bonds provide the strongest protection during deflationary events and also robust returns when times are good. They also avoid a lot of risks that are present in other kinds of bonds you can buy. Benefits of Bonds Just like the other assets in the Permanent Portfolio, bonds are held at all times regardless of what an investor may think is going to happen in the economy...
