Chapter 2
Bonds
Bonds are the starting point for understanding the fixed income market. They represent a standardized form of loan between investors and debt holders and form the foundation of the fixed income market. Although bonds are traded in massive volume daily, they are less known to the general public than the stock market. Unlike stocks, which have indefinite maturity and uncertain dividends that can be withdrawn at will by the issuer, bonds have a fixed maturity and fixed interest at inception (or interest that changes according to an agreed-on formula). Furthermore, while stocks are issued mainly by corporations, bonds have a tremendous variety of issuers, including governments, corporations, and homeowners. This chapter introduces the basic characteristics of bonds, their valuation, and the risks of investing in them. Even if the borrower of the debt is sure to repay the loan, there are other risks to consider if bonds are bought and sold in the market. We quantify and attempt to control them, especially when initiating trades beyond simply buying or selling a single bond.
BASICS OF BONDS
To understand the details of bonds, first consider a simple case where you lend your friend $5 for a week. In the case of such micro-loans, most of the time the $5 is returned after a week with no adjustment made for interest. However, let's take the example to a larger scale. Assume that you have lent money not to a good friend, but to an institution, such as the government. Also, ...
