The paper "Bonds, Bond Prices and the Determination of Interest Rates" is a great example of a report on macro and microeconomics. When investing in bonds, an investor expects three sources of return on investment. These are: coupon payments to be made by the issuer; the capital gains realized when the bond is sold, matures, or is called. This is the difference between the purchase price and the price realized when it is given up; and interest on interest, this is where the investor takes the interim cash flows before maturity and reinvests it to earn extra returns.
The measure of any investment is the interest rate. The interest rate measures the present value of the expected cash flow from the investment to its cost. I = Fc1 + Fc2 + Fc3 + … … … … .. + Fcn 1+r (1+r) 2 (1+r) 3 (1+r) n I = S Fct (1+r) t Where: FC is cash flow in a given period, I am the price of an investment, n is the number of periods and r is the interest rate. This calculated yield is also known as the internal rate of return.
In most cases, calculation of yield is through trial and error method also known as the iterative method Fabbozi (2010). Different measures of yield There are different measures of yield in the bond market namely: Realized yield, yield to call, yield to maturity, current yield, and nominal yield. Realized yield measures the expected return if you sell the bond before maturity (Arthur & Sheffrin, 2003). This measure gives the portfolio manager an opportunity to estimate the performance of a bond based on the planned investment, future market yield, and reinvestment rates Bruce (2012).
The problem with this method is that the manager is forced to make assumptions concerning specified period, future investment, and reinvestment rates. On the other hand, the manager is able to evaluate performance under different interest rates. Current yield Current yield measures cash flow to market price i. e. dividing the annual interest is by the market value. The time value of money and capital gains or losses is not considered when using this method of yield calculation. This calculation only takes into account the coupon interest as the only source of income that will have an effect on an investor's yield. Current Yield = Annual bond interest Price Practical example: Apple Inc 10-year bond with an interest rate of 5% and a market price of 98
Arthur, O., & Sheffrin, S. M. (2003). Economics: Principles in action. New Jersey: Pearson Prentice Hall.
Bruce T (2012) Fixed Income Securities: Tools for today’s Market, John wisely $ sons inc
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Fabbozi J, Man S (2010) Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures, and Valuation, Second Edition John Wiley & Sons
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Oswego State University. (nd). Bonds, Bond Prices and the Determination of Interest Rates, Part II. Retrieved November 23, 2012, from Oswegu education: http://www.oswego.edu/~edunne/340ch6part2.htm
Schwab, C. (2009, Novemberr 25). Bonds Article. Retrieved November 23, 2012, from Schwab global: http://www.schwab-global.com/public/schwab-gcb-en/advice_and_research/market_insight/investing_strategies/bonds/impact_of_interest_rates_on_bond_investments.html
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