Fixed Income Analytics

From changing interest rates and economic fluctuations, to company bankruptcies and credit ratings, there are a multitude of factors that influence the bond market, and therefore the ongoing value of your holdings in your fixed-income accounts. The bond market is also much larger than the stock market.

What is a Bond?

A bond is nothing more than an IOU:

		An indenture, a document that is considered legally binding, spells out the terms and conditions of the loan.
		The principal is the money that you lend to the bond issuer—most bonds have a principal of $1,000.
		The coupon outlines the interest rate that the borrower has promised to pay you (some bonds have floating coupons). It represents the cost of money—the interest rate that the issuer has to offer investors to borrow your money.
		The maturity is the period of time before the bond expires. The borrower has to pay you back the principal at the time that the bond expires, whether it is after 10, 15, 20, or 30 years.
		The yield is the return that you get from investing in the bond—the easiest way to measure yield is the coupon yield, which is at the same level as the coupon. The current yield calculates the return by dividing the coupon by the bond’s market price. The yield to maturity calculates all of the money you will earn from a bond if you keep it till maturity. This includes interest payments, reinvestment of earnings, and the change in the price of the bond above or below your original purchase price.
		The secondary market is where bonds are traded after they are issued. Bonds can trade at a premium to their face value (more than the principal) or at a discount to their face value (less than the principal).
		Interest rate risk is one of the deciding factors in bond prices—changing interest rates can affect bond prices in either a negative or positive way in the secondary market.
		Credit risk is the other deciding factor in bond prices. This refers to the risk you take that you might not get coupon payments and principal on time and in full.

When interest rates go up, your bond returns go down. Say you had purchased a 30-year U.S. Treasury bond in 1993. You would have expected to reap 6.25% interest every year for 30 years.

In 1994 the market fell and interest rates shot up. If you had decided to sell your bond, the market price would have leveled off at $782, a loss of 22% over the original price and your yield to maturity would have turned out to be 8.1%, equaling the market.