After this guide you can
- Separate coupon, current yield and yield to maturity
- Estimate price sensitivity using duration
- Understand credit, liquidity and currency risk
You become a creditor, not a shareholder
Debt securities specify interest and principal payments. The issuer may be a government or company. Read face value, maturity, rate type, claim seniority and early-call rights. A bond derivative does not necessarily confer ownership of the bond or creditor rights.
Holding to maturity produces contractual repayment only if the issuer performs; default risk remains. If money is needed earlier, market price and liquidity matter. A bond fund also generally lacks a single bond’s defined date for returning your capital.
Coupon is not the same as yield
Coupon follows issuance terms, but your yield also depends on purchase price. Current yield divides annual coupon by price and does not fully reflect principal repayment gains or losses. Yield to maturity is the rate implied by promised cash flows and current price; achieving that outcome depends on payment, holding and reinvestment conditions.
Some markets quote prices as percentages of face value, while settlement also includes accrued interest. Do not equate clean price with the final payment. Payment schedules and day-count conventions affect accrued interest.
Why can rising yields lower prices?
When required yields rise, existing fixed cash flows generally become attractive at a lower price. Modified duration estimates price sensitivity to small yield changes. Longer maturities often carry greater sensitivity, but coupons and contractual features also matter.
Duration is not time remaining to maturity. Its linear relationship is approximate: convexity matters for larger changes, and embedded options can alter call behaviour. Central-bank rates need not move simultaneously or equally with every short- and long-term market yield.
Issuer credit and hidden risks
Higher yields may compensate for credit risk or poor liquidity. Check debt, payment coverage, issuer revenue currency and covenants. Credit ratings inform analysis but do not guarantee repayment. The spread to benchmark bonds can widen as issuer concerns rise.
For an account in another currency, bond returns and exchange-rate changes are separate components. Early redemption can force reinvestment at lower rates. Before trading, plan for needing an early exit and selling costs in a thin market.
Educational calculation · hypothetical numbers
Two calculations that must not be confused
A hypothetical bond has face value 1,000 dollars, annual coupon 40 and clean price 950. Modified duration is assumed to be 5 solely for this example.
| Step | Result and interpretation |
|---|---|
| Coupon rate | 40 ÷ 1,000 = 4% |
| Current yield | 40 ÷ 950 ≈ 4.21%; not the same as yield to maturity |
| Assumed yield rise of 0.5 percentage points | Approximate price change: −5 × 0.005 = −2.5% |
| Approximate impact on a 950-dollar price | About 23.75 dollars lower; estimated price 926.25 |
Duration assumes a small yield change and other factors constant; convexity, received coupons, accrued interest, costs and credit changes are excluded. Yield-to-maturity calculation requires dates and all payment cash flows.
Before submitting an order
- Issuer, currency, maturity and contractual rights are clear.
- I distinguished coupon from current yield and yield to maturity.
- I reviewed duration, credit risk and callability.
- I know settlement amount, exit liquidity and currency impact.
Mistakes to recognise
- Assuming a fixed coupon prevents price losses.
- Choosing only the highest yield without credit analysis.
- Equating duration with maturity or assuming guaranteed principal in bond funds.
Check your understanding
Does a central-bank policy-rate cut guarantee every corporate bond will rise?
Show answer and reasoning
No. Required market yields, credit risk and liquidity also matter. Rising issuer concerns can offset lower general interest rates.
Key terms
- Coupon
- Interest payments under a debt security’s terms.
- Modified duration
- An approximate measure of relative price sensitivity to a small yield change.
- Default risk
- The possibility that the issuer fails to make promised payments.
For further reading
This guide was independently written. The official sources below support further study of the concepts; product rules and local regulations may differ.
This guide is educational, not a personal buy or sell recommendation. Examples do not establish specifications of products offered by CAPITEX.