Economics
Discount Bond
A discount bond is a bond that is issued for less than its face value, typically because it pays no interest or a lower interest rate than the market rate. Investors purchase discount bonds at a discount to their face value and receive the full face value when the bond matures. The difference between the purchase price and the face value represents the investor's return.
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10 Key excerpts on "Discount Bond"
eBook - PDF- Patrick J. Brown(Author)
- 2006(Publication Date)
- Wiley(Publisher)
Delivery versus payment A mechanism that enables the simultaneous exchange of securities and cash. As a result neither the purchaser nor the seller of the securities is at risk of default by the other party. Dematerialized securities Securities held in a book transfer system with no certificates. Denomination The denomination of a bond is usually the smallest amount of the bond that it is possible to hold. This could be on a central register or on the certificate with bearer bonds. Example C.7 In the UK gilt-edged market, where the holdings are held on a central register, it is possible to hold £0.01 of a bond – hence the bonds have a denomination of just 1 p. However, in the eurodollar market the bond denominations are usually at least $1000 and in some cases as much as $100 000 or even $1 million. A few bearer bonds have been issued with multiple denominations, e.g. $10 000, $25 000 and $100 000. Derivative A generic term for an option and/or a future to buy or sell a security or a combination of instruments. The terms may be very complicated. Dirty price The price of a bond including any accrued interest. If you purchase a bond, this is the price you will have to pay. The ‘dirty’ or ‘gross’ price of a bond is its clean price plus or minus any accrued interest. Appendix C: Bond Market Glossary 189 Discount rate A measure, expressed as an annual rate per cent, of how much the price of a security is less than its redemption value. This is usually applied to money market instruments that do not have a coupon. Example C.8 If an instrument that will be redeemed at 100 in 3 months’ time is priced at 98, it has a discount of (100 − 98) × 4 / 100 = 8 %. Discounted margin The discounted margin for a floating-rate note measures the yield premium or discount of the note relative to its indicator rate. It allows for both the current yield effect on the margin and allows for any capital gain.
eBook - PDFHealthcare Finance
Modern Financial Analysis for Accelerating Biomedical Innovation
- Andrew W. Lo, Shomesh E. Chaudhuri(Authors)
- 2022(Publication Date)
- Princeton University Press(Publisher)
These interest rates are reflected in the prices of bonds, which is the topic we turn to next. 5.2 VALUING Discount BondS AND THE TERM STRUCTURE OF INTEREST RATES The simplest bonds to value are called discount or zero-coupon bonds. These bonds have no intermediate coupon payments. They have only one payment which is made at a predetermined time in the future, called the bond’s maturity date. The amount the bond pays out at maturity is called its face or par value. The reason these bonds are also called Discount Bonds is because, in general, a dollar in the future is worth less than a dollar today, so they trade at a discount relative to their par value. For ex- ample, a bond that promises to pay only one single payment of $1,000 one year from now will be priced at something less than $1,000 today, given that people prefer money today to money a year from now, other things equal. When there’s absolute certainty that future payments will be made, a bond is said to be default-free. In the case of zero-coupon bonds, when there’s no risk of default, the bond’s price reveals the market’s risk-free exchange rate between a dollar today and a dollar in the future at the bond’s maturity date. Once this exchange rate has been set, we can calculate the spot interest rate, the risk-free interest rate between today (“on the spot,” hence the name) and the maturity date. This spot rate is a critical component for calculating the appropriate discount rate to use when performing NPV calculations. More formally, suppose a T -period Discount Bond pays a face value of F at date T and has a price of P 0,T today (where the subscript “0, T ” indicates the date on which the bond is priced—today, in this case—and the maturity date).
eBook - PDFTreasury Finance and Development Banking
A Guide to Credit, Debt, and Risk
- Biagio Mazzi(Author)
- 2013(Publication Date)
- Wiley(Publisher)
CHAPTER 5 Bond Pricing W e have built all the tools needed to approach the topic that is at the center of any discussion of credit and the activity of a treasury: debt. We have seen how to generate and discount future cash flows, we have seen how a choice of discounting is highly sensitive to the credit environment, and we have explicitly discussed credit. It is now time to use this knowledge to observe and price debt instruments. In order to build a self-contained narrative we shall begin with an intro-duction to the basic concepts surrounding a bond. We shall then move on to the very important issue of trying to isolate the credit component of a bond in a more or less explicit way; we shall present the concepts of benchmarks, asset swaps (introduced here and revisited in the following chapters); and an analysis of the relationship between bonds and credit default swaps. We shall conclude with a section on how to price distressed and/or highly illiq-uid bonds and one where this final topic is presented through a numerical example. 5.1 WHAT IS A BOND? We have defined a bond as a way for an entity to raise capital without relinquishing control. Bonds are among the oldest financial instruments and among the first types of securitization, 1 a way of turning the scattered revenues of a government or a corporation into a well-defined and tradable instrument. An entity forecasts a fairly regular set of revenues (from sales for a company or from taxes and investments for a government) but needs an immediate and large cash amount: on the back of its revenues it will issue a bond in which it promises to return the amount at maturity and to 1 The interested reader is directed toward Niall Ferguson’s The House of Rothschild for a riveting narration of what bond trading was in truly illiquid markets. 127 128 TREASURY FINANCE AND DEVELOPMENT BANKING pay interest at regular dates. The regularity of the entity’s revenues should ensure the regular payment of coupons.
eBook - ePubTreasury Finance and Development Banking
A Guide to Credit, Debt, and Risk
- Biagio Mazzi(Author)
- 2013(Publication Date)
- Wiley(Publisher)
CHAPTER 5 Bond PricingWe have built all the tools needed to approach the topic that is at the center of any discussion of credit and the activity of a treasury: debt. We have seen how to generate and discount future cash flows, we have seen how a choice of discounting is highly sensitive to the credit environment, and we have explicitly discussed credit. It is now time to use this knowledge to observe and price debt instruments.In order to build a self-contained narrative we shall begin with an introduction to the basic concepts surrounding a bond. We shall then move on to the very important issue of trying to isolate the credit component of a bond in a more or less explicit way; we shall present the concepts of benchmarks, asset swaps (introduced here and revisited in the following chapters); and an analysis of the relationship between bonds and credit default swaps. We shall conclude with a section on how to price distressed and/or highly illiquid bonds and one where this final topic is presented through a numerical example.5.1 WHAT IS A BOND?We have defined a bond as a way for an entity to raise capital without relinquishing control. Bonds are among the oldest financial instruments and among the first types of securitization,1 a way of turning the scattered revenues of a government or a corporation into a well-defined and tradable instrument. An entity forecasts a fairly regular set of revenues (from sales for a company or from taxes and investments for a government) but needs an immediate and large cash amount: on the back of its revenues it will issue a bond in which it promises to return the amount at maturity and to pay interest at regular dates. The regularity of the entity’s revenues should ensure the regular payment of coupons.An investor will decide to buy a certain amount of this bond (effectively lending money to the entity) and the price for this bond will be driven by the investor’s trust in the entity’s abilities to meet its obligations. The price at a time t of a bond B
eBook - PDF- Scott Besley, Eugene Brigham, Scott Besley(Authors)
- 2021(Publication Date)
- Cengage Learning EMEA(Publisher)
It is important to understand the valuation concepts presented in this and the next few chapters because they represent the general foundations of finance. 1 In this chapter, we primarily discuss bonds (debt) from the perspective of a corporation. Most of the characteristics we describe for corporate debt also apply to government debt. debt A loan to a firm, government, or individual. discounted securities Securities selling for less than their par values when issued. 125 CHAPTER 6: Bonds (Debt)—Characteristics and Valuation Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. purchase prices and maturity values represent the dollar returns earned by investors. 6-1c Short-Term Debt Short-term debt refers to debt instruments with original maturities of one year or less. Some of the more common short-term debt instruments are described here. Treasury Bills. Treasury bills (T-bills) are discounted securities issued by the U.S. government to finance its operations and programs. When the U.S. Treasury is- sues T-bills, the prices are determined by an auction process: interested investors and investing organiza- tions submit competitive bids to purchase T-bill issues. 2 T-bills are issued electronically with face values ranging from $100 to $5 million (in multiples of $100), and with maturities that range from a few days to 52 weeks at the time of issue.
eBook - PDFDerivative Instruments
A Guide to Theory and Practice
- Brian Eales, Moorad Choudhry(Authors)
- 2003(Publication Date)
- Butterworth-Heinemann(Publisher)
2 Overview of Fixed Income Securities In this chapter we present an introduction to fixed income analysis, particularly the pricing of default-free zero-coupon and coupon fixed-term bonds. Further reading is given in the bibliography. 1 2.1 Basic concepts We are familiar with two types of fixed income security, zero-coupon bonds , also known as Discount Bonds or strips , and coupon bonds . A zero-coupon bond makes a single payment on its maturity date, while a coupon bond makes regular interest payments at regular dates up to and including its maturity date. A coupon bond may be regarded as a set of strips, with each coupon payment and the redemption payment on maturity being equivalent to a zero-coupon bond maturing on that date. This is not a purely academic concept ± witness events before the advent of the formal market in US Treasury strips, when a number of investment banks had traded the cash flows of Treasury securities as separate zero-coupon securities. 2 Bonds are described by their issuer name, coupon rate and term to maturity, and those that have fixed coupons and fixed maturity terms are known as conventional or vanilla bonds. An example of the basic description of a bond is given in Figure 2.1, the Bloomberg ``DES'' page. The literature we review in this section is set in a market of default-free bonds, whether they are zero-coupon bonds or coupon bonds. The market is assumed to be liquid so that bonds may be freely bought and sold. Prices of bonds are determined by the economy-wide supply and demand for the bonds at any time, so they are macroeconomic and not set by individual bond issuers or traders. 1 Parts of this chapter first appeared in Choudhry (2001), Chapter 3. 2 These banks included Merrill Lynch, Lehman Brothers and Salomon Brothers, among others (Fabozzi, 1993). The term ``strips'' comes from Separate Trading of Registered Interest and Principal of Securities, the name given when the official market was introduced by the Treasury.
No longer available |Learn moreInvestments
An Introduction
- Herbert Mayo(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
When it sells at a discount (e.g., $952), the current yield is only 10.5 percent. How -ever, the yield to maturity is 12 percent. Thus, the yield to maturity exceeds the current yield. If the bond sells at a premium, the current yield exceeds the yield to maturity. For example, if the bond sells for $1,052, the current yield is 9.5 percent ($100 4 $1,052) and the yield to maturity is 8 percent. The yield to maturity is less in this case because the loss that the investor must suffer when the price of the bond declines from $1,052 to $1,000 at maturity has been included in the calculation. Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 C H A P T E R F O U R T E E N The Valuation of Fixed-Income Securities 499 Exhibit 14.4 presents the current yield and the yield to maturity at different prices for a bond with an 8 percent annual coupon that matures in ten years. As may be seen in the table, the larger the discount (or the smaller the premium), the greater are both the cur -r r rent yield and the yield to maturity. For example, when the bond sells for $850, the yield to maturity is 10.49 percent, but it rises to 12.52 percent when the price declines to $750. Discounted bonds offer investors attractive opportunities for financial planning. For example, a person who is currently 60 years old may purchase discounted bonds that mature after five years to help finance retirement. This investor may purchase sev -eral bonds that mature five, six, seven years, and so on, into the future. This portfolio will generate a continuous flow of funds during retirement as the bonds mature. Discounted bonds generally result from an increase in interest rates. If interest rates fall, bonds would sell for a premium, so the previous strategy cannot be executed. An alternative but similar strategy uses zero coupon bonds, which always sell for a dis -count.
eBook - PDF- Timothy Mayes(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
Because the make-whole call feature makes calling a bond more expensive for the issuer, it is only rarely invoked. However, the bonds are continuously callable, on short notice, as opposed to only once a year. The yield to call isn’t very useful for bonds with a make-whole feature, though we can calculate it using the YIELD function. The REDEMPTION argument would be calculated using the PRICE function, with its YLD argument being equal to the Treasury rate plus the spread. Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Bond Return Measures 315 Returns on Discounted Debt Securities Not all debt instruments are bonds of the type that we have discussed earlier. Money market securities are short-term, high-quality, debt instruments sold on a discounted basis. That is, they do not pay interest; instead, they are sold for less than their face value. Because the full face value is returned to the investor at maturity, the interest is the difference between the face value and the purchase price. Examples of this type of security would include U.S. Treasury Bills, commercial paper, banker’s acceptances, and short-term municipals. Returns on discounted securities are usually quoted on a bank discount basis. The bank discount rate (BDR) is calculated as follows: BDR 5 FV 2 P 0 FV 3 360 M (10-3) where FV is the face value of the security, P 0 is the purchase price, and M is the num- ber of days until maturity.
eBook - PDFFundamentals of Financial Instruments
An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives
- Sunil K. Parameswaran(Author)
- 2022(Publication Date)
- Wiley(Publisher)
For par bonds, the two effects neutralize each other, and the price remains unchanged. For premium bonds, the first effect dominates, and the price steadily declines as we approach maturity. For Discount Bonds, however, the second effect dominates, and the price steadily increases from one coupon date to the next. EXAMPLE 4.2 Consider a bond with 10 years to maturity and a face value of $1,000. Assume that the YTM is 8% per annum while the coupon is 6% per annum. The bond will sell at a discount. The price can be calculated to be $864.10. Now let us move one period ahead to a time when there are only 9.5 years left. The price can be calculated to be $868.66. As expected, the price has increased. Now consider the same bond but assume that the coupon is 10% per annum. This bond will sell at a premium. The price when there are 20 coupons left is $1,135.90. Six months later, if the yield were to remain constant, the price will be $1,131.34. As expected, the price has declined. ZERO-COUPON BONDS Unlike a plain-vanilla bond, which pays coupons at periodic intervals, zero-coupon bonds, also known as deep Discount Bonds, do not pay any interest. Such instruments are always traded at a discount to the face value, and the holder at maturity will receive the face value. For instance, consider a zero-coupon bond with a face value of $1,000 and 10 years to maturity. Assume that the required yield is 8% per annum. The price may be computed as follows. 1 , 000 ( 1.04 ) 20 = $456.39 Notice that we have chosen to discount at a rate of 4% for 20 half-yearly peri-ods, and not at 8% for 10 annual periods. The reason is that in practice a potential investor will have a choice between plain-vanilla bonds and zero-coupon bonds. To draw meaningful inferences, it is imperative that the discounting technique be com-mon. Since the cash flows from plain-vanilla bonds are usually discounted on a semi-annual basis, we choose to do the same for zero-coupon bonds.
eBook - PDF- Roy E. Bailey(Author)
- 2005(Publication Date)
- Cambridge University Press(Publisher)
This process can lead to the securitization of loans. For instance, loans on real estate can be packaged together and traded as bonds backed by the property that was mortgaged to obtain the loan. Bond rating agencies (e.g. Moody’s or Standard & Poor’s) make a living out of appraising the prospects for bonds’ default. However, this important topic is not pursued here; in the remainder of this chapter, except where explicitly noted, it is assumed that default does not occur in any state of the world. In this sense, at least, bonds are risk-free. Even in the absence of default, bonds are not entirely free of risk, as explained below. 12.2 Zero-coupon bonds 12.2.1 Nominal zero-coupon bonds Zero-coupon (pure discount) bonds play a pivotal role in bond market analysis. The reason is simple: zero-coupon (ZC) bonds are much easier to analyse than coupon-paying bonds. Any ZC bond can be specified with just two parameters: its face value, m , and the date, T , at which the issuer pays m to the bond’s holder. Unless explicitly indicated otherwise, ZC bonds are assumed to be nominal in the sense that the redemption value is fixed in units of account – e.g. m = $100. 6 A bond covenant , appended to the indenture, might specify how conflicts between issuer and holder should be resolved in the event of dispute, possibly by passing rights of corporate control to the bondholders. The label ‘ debentures ’ encompasses a class of securities that include clauses allowing holders to obtain a stake in the issuing company under certain conditions. For an entertaining discussion of the differences between British and American usage in this and other respects, see The New Palgrave Dictionary of Money and Finance (Newman, Milgate and Eatwell, 1992, Vol. II, pp. 102–3). Bond markets and fixed-interest securities 287 It is usual to express the second parameter as the time to maturity , n ≡ T − t , where t denotes the present date.
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