Darren Webb Development Team Montego Data Limited
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Coupon and Yield
Prices of bonds with a 6% nominal coupon
Thirty Year Bond
If the yield is 5% then 100 currency units today are worth the same as 105 units in 1 year.
100 today = 105 in 1 year ; 1 today = 1.05 in 1 year ; 1 / 1.05 today = 1 in 1 year ; 106 / 1.05 today = 106 in 1 year.
Thus, at a 5% yield, 106 in 1 year is worth 106 / 1.05 is approx 100.95 today.
In the case of a Two-Year Bond annual coupon 6% and yield 5%
6 / 1.05 today = 6 in 1 year ; 1 today = 1.05 in 1 year ; 1 in 1 year = 1.05 in 2 years ; 1 today = 1.05 * 1.05 in 2 years ( 1.1025 )
( 6 / 1.05 ) + (106 / 1.052) approx 101.86
But what if, for some particular need, an investor wishes to acquire a different shape of cashflows ?
For example, what if an investor wishes to put money away until 2021 and not receive any coupons before then ?
Or what if that investor wishes to receive coupons, and only coupons, from 2016 until 2021 ?
Since there is sometimes a demand for such customised collections of cashflows, the US Government allows bonds to be stripped.
This is an exchange facility; a dealer hands in a US Treasury Bond and receives in return the same cashflows but in separately tradable form.
These cashflows are called Separately Traded Registered Interest and Principal Securities.
There is always another subtle issue to consider.
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