Bond markets are referred to as fixed income markets, why? Because the bond promises to pay a certain coupon rate when it is issued. The amount of money the bond pays, or coupon, is fixed and does not change over the life of the bond. Interest rates however change daily or even hourly as bonds are traded around the world. So even though they are fixed income, they are not fixed principal, since the coupon dollar amount cannot change, the value of the bond changes in response to interest rates. This is why bond prices move inversely, or opposite, of interest rates.
If rates are 10% and a bond is issued at par, if rates then move to 5% what is the value of the bond? The answer is that the value of the bond has to adjust so that the bond is yielding the same rate of interest as just issued bonds. So if the bond is paying $100 per year, 5% = $100/x, so x = $2,000.
Now look at page C10 of the Wed Jan 24, 2007 WSJ. The article says that Brazil's Global bond is hailed amid Latin American Jitters, but isn't everyone always jittery about Latin America?
Anyway, the bond is priced at 106.3385 to yield 6.635%. This is 1.73 percentage points or 173 basis points over the 30 yr Treasury. A basis point is 1/10 of one percent. Hence 100 basis points equal one percent.
Why would investors be willing to accept an increase in yield of only 1.73 % over AAA paper from Brazil when just down the road, Ecuador is rated CCC, ie default is near?
IN the next column Affinion Loan is going to pay in kind interest payments instead of cash. Is this a good deal. You buy debt and you get more debt? The yield is 625 basis points over the LIBOR, London Interbank Overseas rate of 5.36%. So they are paying a whopping 11%. Want to buy some, why or why not?
Okay let's see some posts on this one! We will be exploring this issue more in Intermed II class on monday
DLE
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