20 years: Debt capital markets
Buyers and sellers of new bonds need to agree on a price at which to transact. In this series of videos, Nigel describes the new issue process that brings together all the components of pricing a bond, and surrounding conventions which are applied in the various different bond markets. In this first video of the series, Nigel outlines the various components considered when pricing a bond before specifically detailing how to price US Dollar bond.
Buyers and sellers of new bonds need to agree on a price at which to transact. In this series of videos, Nigel describes the new issue process that brings together all the components of pricing a bond, and surrounding conventions which are applied in the various different bond markets. In this first video of the series, Nigel outlines the various components considered when pricing a bond before specifically detailing how to price US Dollar bond.
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12 mins 1 sec
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 a bond yield is reflected in the bond price
Identify the convention used in the US dollar bond market for coupon payments
Understand how a bond’s yield to maturity is calculated in the US
Describe a coupon rounding convention
Understand the day-count convention for US dollars and what this is used for
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The bond’s cash flows then 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 twice a year, it is typical in the US dollar 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 US dollar market, the convention is for accrued interest to be calculated on a 30/360 basis i.e. each whole month comprises 30 days hence for the purposes of the accrued interest calculation, there are only 360 days in a year.
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