re: Bonds. Explanation needed.

In general there are two types of bonds: Zero-Coupon Bonds and Coupon Bonds.


Bond Terminology:

Face Value = Notional amount used to calculate interest payments

Coupon Rate = Determines the amount of each coupon payment, expressed as an APR with the appropriate compounding rate

Coupon Payment = (Coupon Rate*Face Value) / Number of Coupon Payments per Year

Yield to Maturity (YTM) = Internal Rate of Return (IRR) of the Coupon Bond


Zero-Coupon Bond:

- Pay face value at maturity
- No coupon interest payments

If a one year zero-coupon bond with face value of $100 has a price of $96.62, then its YTM can be calculated as follows:

Price = Face Value/(1+YTM)^n
96.62 = 100/(1+YTM)^1
This gives a YTM of 3.5%


Coupon Bonds:

- Pay face value at maturity
- Pay regular coupon interest payments

Let's say you buy a 5-year US treasury bond of $1000 with coupon rate of 5% and semi-annual coupons, then the coupon payments you will receive every six months can be calculated as follows:

Coupon Payment = (Coupon Rate*Face Value) / Number of Coupon Payments per Year = (5%*1000)/2 = $25

The price and YTM formula for a coupon bond is pretty complicated and you will need Excel to solve it. If you want me to show you can example of that, I'd be happy to.