Bond basics by Moorad Choudhry

Bond basics by Moorad Choudhry

Figure 2.1 Cash flows associated with a six-year annual coupon bond
The upward facing arrow represents the cash flow paid and the downward facing 
arrows are the cash flows received by the bond investor. The cash flow diagram for a 
six-year bond that had a 5% fixed interest rate, known as a 5% coupon, would show 
interest payments of £5 per every £100 of bonds, with a final payment of £105 in the 
sixth year, representing the last coupon payment and the redemption payment. Again, 
the amount of funds raised per £100 of bonds depends on the price of the bond on the 
day it is first issued, and we will look further into this later. If our example bond paid 
its coupon on a semi-annual basis, the cash flows would be £2.50 every six months 
until the final redemption payment of £102.50.
Gilts and US government bonds, known as Treasuries, pay coupon every six month. 
Other bonds pay annual coupon or quarterly coupon. 
Let us examine some of the key features of bonds.
Type of issuer. The primary distinguishing feature of a bond is its issuer. The nature 
of the issuer will affect the way the bond is viewed in the market. There are four 
issuers of bonds: sovereign governments and their agencies, local government 
authorities, supranational bodies such as the World Bank and corporations. Within 
the corporate bond market there is a wide range of issuers, each with differing 
abilities to satisfy their contractual obligations to investors. The largest bond markets 
are those of sovereign borrowers, the government bond markets. 
Term to maturity. The term to maturity of a bond is the number of years after which 
the issuer will repay the obligation. The maturity of a bond refers to the date that the 
debt will cease to exist, at which time the issuer will redeem the bond by paying back 
to bondholders the principal or face value. The term to maturity is an important 
consideration in the make-up of a bond. It indicates the time period over which the 
bondholder can expect to receive the coupon payments and the number of years 
before the principal will be paid in full. The bond’s yield is also depends on the term 
to maturity. Finally, the price of a bond will fluctuate over its life as yields in the 
market change and as it approaches maturity. As we will discover later, the volatility 
of a bond’s price is dependent on its maturity; assuming other factors constant, the

Bond basics by Moorad Choudhry