Bond Math Without the Math推荐.pdfVIP

3 BOND MATH—WITHOUT THE MATH It’s time to get some of the hard stuff under our belts. Truthfully, though, it’s not so hard. People hear “math and they recoil. In fact, at the basic professional user level (as opposed to the “quants”), what market participants refer to as bond math is simply straightforward arithmetic. Basic Bond Pricing Let’s work with a plain vanilla, 6% coupon bond. It pays $6 for every $100 in principal each year (annual frequency) until it matures in five years. This makes it a five-year bond. We’ll assume for now that the bond presents no risk of default, such as a U.S. government bond. 1 That is, the borrower will definitely pay whatever it promises to. But this does not mean that the bond is riskless. No, no! Not by any stretch of the imagination. Pay close attention. The government sells, or “issues,” the bond at par. Par means that investors have paid the same price as the face value of the bond. On the bond’s “face” it says $100, because that’s the principal—the amount the government will return to the investor after five years. You lend the gov- ernment $100, it promises to give you $6 every year (hence 6%) plus $100 at maturity. Par is short for “parity.” Parity, in turn, suggests a sense of evenness, or equivalence, or fairness, if you like. If investors are paying par, this means that, given their perception of the state of 23 24 • Fundamental Principles of Bond Structure, Pricing, and Investing the world (including their view of the future) and the savings at their disposal, they are satisfied to receive what the bond promises to pay. They want no less and demand no more than 6% for the money they’re lending to the government at this point in time. Consider the bond “dealers.” You can think