What this graph shows the interest yield on the 10 year Indian Government bond over the past 5 years. We can clear see that yields, after a bottom near 2013 of about 7.3%, have now (~2017) come to a value of 6.5% after hitting highs of 9%. This means that overall interest rates are down and is because of significant lower rate of inflation
A basic coupon bond has the following features
- On issue date, initial bond face value is paid to issuer (investor buys a bond)
- Regular coupon payments received by investor (represents the interest)
- At maturity, bond face value is redeemed (returns the loan)
- Consider a coupon bond with a face value of $100,000;
- Bond maturity: 5 years
- Coupon Rate: 4%;
- Coupon Payment: Semi-annual
Why is it called a bond coupon? Read more at Coupon
Most governments raise a lot of debt (short, medium and long term) to finance investment and expenditure.
Some basic government bonds
- A gilt is a UK Government liability in sterling, issued by HM Treasury and listed on the London Stock Exchange
- The term “gilt” or “gilt-edged security” is a reference to the primary characteristic of gilts as an investment: their security
- This is a reflection of the fact that the British Government has never failed to make interest or principal payments on gilts as they fall due
- These have a maturity of 5, 10, 30 and 50 years
US Treasury – Bills, Notes and Bonds
The US treasury issues a number of securities to raise money required for various government program
These are three key types of securities
- Treasury Bills (T-Bills) have a maturity of < 1 year
- Treasury Notes (T-Notes) have a maturity of 2, 3, 5, 7 and 10 years
- Treasury Bonds (T-Bond) have a maturity of 30 years
Japanese Government Bonds (JGB)
JGB’s are issued by the Japanese government, which is responsible for interest and principal payments
Payment is guaranteed by the Government
- JGB’s are a financial product traded in the market. So, you don’t need to wait for maturity.
- The principal amount will be paid at maturity
- Maturities can vary from 2 to 40 years
Government Securities and Types
The next topic will be on Fixed Income Security types and features.
A bond is a borrowing (or lending) and is a loan in structure.
Let us look at a loan transaction.
Lender: Gives Money. For a period of time. At a rate of interest.
Borrower: Borrows for this period of time. Has to pay regular interest and finally the principal amount at maturity.
What are the challenges?
Lender does not get his money till maturity – Liquidity Risk
This is the chief problem in a loan transaction which is one to one (OTC).
Borrower may default – Credit Risk. We will look at this later.
What is a Bond?
A bond also called a Fixed Income Security .
- A bond is a ﬁnancial security that promises to pay a ﬁxed income stream at fixed dates in the future
- Issued by governments, state agencies municipalities and corporations
- When a corporation or government wants to borrow money, it often sells a bond
So we have the issuer of a bond (borrower) and the investor of the bond (lender)
The borrower promises to give the investor:
- Regular interest or coupon payments every period until the bond matures.
- The face value of the bond when it matures
Bonds are characterized by
- Maturity date
- Face, par or principal value
- Interest Rate (or Coupon Rate)
- Number of interest payments per year (typically 2; also called coupon payments)
Loans are classified by the initial maturity or tenor of the borrowing
Loans are also classified by the Issuer of the loan
Combining the two we see a loan has two key principal characteristics – issuer and duration of borrowing
What are the benefits of bonds to investors?
- Investors receive ‘coupon’ also known as the interest payment.
- On maturity, investors receive back the principal which they had originally invested
- Depending on the quality of the borrower, the investor derives a measure of comfort regarding the safety of his investment.