All things finance

So recently I have had alot of time enjoying my short-lasting holidays. I decided to do some research on bonds and find out more about bond trading. Turns out that it is really interesting. It is my passion to learn more about these kind of stuff so that in the future I can make alot of money from them. That's my aim anyway. Getting there is the difficult part. These are a few things I learnt from my studies.(beware tonnes of jargon ahead)

1. The difference between bond yields and zero rates

Imagine this situation. I will pay you $100 in a future date, say 1 year from now. But today, you have to lend to me $90 something dollars. The bond yield is the percentage return that you will get for your money that you lent me today and receive $100 1 year from now. Say you lent me $90 today, and I paid you $100 1 year from now, the yield is 11.1%, expressed in annual terms. The bond yield is specific to that bond only. Zero rates, on the other hand, is the yield for zero-coupon bonds. Its the single interest rate that will equate the present value of the bond to the par value of the bond, and expressed in annual terms. To price a coupon bond, we need to know the zero rates to appropriately price a coupon bond.

2. How to price a bond

Bonds have to be discounted back to the present, and we need to discount every cash flow that the bond will pay to the present. We need to discount it using the appropriate interest rate, that way, we can ensure the true value of the bond at the present. How much we should pay for a bond is determined by its intrinsic value, which in turn is the present value of all the future cash flows from the bond. If the bond price is less than the intrinsic value, there is opportunity for a profit. First buy the undervalued coupon-bond, then sell equivalent zero-coupon bonds that matches every cash flow of the coupon-bond, and pocket the difference. A free lunch!

3. The duration of a bond

Bond duration is the average waiting period for the cash flows of the bond. The term to maturity is not an accurate measure of the waiting period for a bond. Imagine if a bond pays $100 today, and another $50 50 years from now. Would it really be said that the investment period is 50 years? Duration captures the essence of the bond, so in that bond I just mentioned the duration is actually 0.2 years using the formula for calculating duration.

4.,5.,6., alot about bond properties


So really, I'd love to learn more about bonds. In the past I have mostly been preoccupied with shares. But learning bonds have really helped my understanding alot. I hope to find out more about the finance world so that I can profit from that. Will see into the future that looks good at the moment.