20 years: Debt capital markets
In this second part of the series, Nigel explains how to price a Euro denominated bond for the theoretical issuer, XYZ Corporation, using the building blocks outlined in the previous video. In this example, XYZ issues an eight-year bond.
In this second part of the series, Nigel explains how to price a Euro denominated bond for the theoretical issuer, XYZ Corporation, using the building blocks outlined in the previous video. In this example, XYZ issues an eight-year bond.
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7 mins 52 secs
A bond represents a series of cash-flows. Investors buying bonds acquire rights to receive those cash-flows at a series of dates – the interest payments during the life of the bond (the coupons) and return of the money at maturity (redemption). For new bonds, buyers and sellers need to agree a price and a yield (discount rate) to arrive at a present value, or price, at which they can transact. The yield is a component of the risk-free rate plus a risk premium (a credit spread). The choice of benchmark hinges on the currency of issue and the conventions that apply to bonds issued in that currency.
Key learning objectives:
Understand how the bond yield is reflected in the bond price
Identify the convention used in the euro bond market for coupon payments
Understand how a bond’s yield to maturity is calculated in the euro bond market
Define Euribor and what is an interest-rate swap curve
Describe the coupon rounding convention in euros
Understand the day-count convention for euros and its uses
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The bond’s cash flows need to be discounted to calculate the yield of the bond. Calculating the yield on the bond has two components:
To help future investors value and trade the bond during its life, day-count and business day conventions need to be borne in mind. As soon as XYZ’s bond is issued, it is free to trade, which means investors are free to buy and sell the bonds. The issuer’s obligation to pay coupons and redeem the bonds at maturity is limited to who owns the bonds at the time the obligations become due. Since coupons are usually only paid annually, it is typical in the euro market for each investor who sells bonds to have the buyer compensate them for interest accrued during the time they held the bond.
Day-count conventions set the framework for investors to calculate interest accrued when a bond has not been held for the full period of a coupon. In the euro market the convention is for accrued interest to be calculated on an Actual/Actual basis i.e. the calculation uses the actual number of days in the shortened period and the actual number of days in the full interest calculation period.
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