Glossary

This demonstrates the essential features of fixed rate bonds. As interest rates rise the price of the bond will fall, and vice versa.

Interest Rates Up ->> Bond Prices Down

Interest Rates Down ->> Bond Prices Up

In order to compare bonds issued at different times by the same provider, the concept of a bond's yield was developed. The yield on a bond is simply a measure of the return that the bond will provide, both in terms of the interest or coupons that it pays and any expected change in its price.

For example, the 7% fixed rate bond described above, would fall in price as noted if the general level of interest rates rose. In this situation it would be possible to buy the bond for say a price of 95%. The yield on the bond in this case would be the return that this bond would provide both in terms of the coupons of 7%pa and the return of 5% being the expected increase in the bond price, from 95% to 100%, if held to maturity.

There are many different kinds of yield i.e. running yield, gross redemption yield, etc. This course is not designed to cover these in detail. The main point however is that the yield on a bond generally expresses its expected total return and as with the coupon is expressed as a percentage.

As a final point on yields, it is important to note that higher yielding bonds in general have higher risk. Thus the probability of default is typically higher on bonds with higher yields.

The concept of a yield leads on to the idea of a yield curve. This is simply a term to describe the different yields that bonds with different maturities pay. In general, although not always, longer term bonds pay higher yields. This is similar to the way that longer term fixed rate deposits also generally pay a higher rate than short term deposits.