- See Bond Price for details on pricing.
- Tradable Inflation-Protected Securities (TIPS) are inflation protected bonds.
How Bonds Work
- Lender lends money to the government (usually US Treasury)
- Coupon payments pay regularly:
- Semi-annually for US Treasury
- Annually for other countries
- Principal (=par, base) amount is paid at the maturity;
- Time To Maturity (TTM) is time from now to when the principal pays
- Yield
- Current Yield
- Yield to Maturity: Expectation Hypothesis defines yield to maturity as the expected rate of return if held til maturity.
Cash Flow Structure of a Bond
Governments are the borrowers of money in this transaction.
- Government “issues” bonds regularly, which is
- Primary Market: Treasury sells bonds (millions of $ worth) mostly to private Investment Banks
- Secondary Market: Investment banks sell smaller chunks to private investors / bond holders sell to each other
- Governments pay coupon and principal through
- Tax revenue
- Issuing more bonds
Bonds are an important part of a portfolio because…
- Are near-riskless investments as they generate stable cash flows. The only risks are: inflation risk—when the government doesn’t have the money, they’ll just print more money. This causes inflation which devalues the bonds.
- Are very liquid, since many people are willing to buy bonds in most scenarios, even in recessions.