A zero-coupon bond (also called a discount bond or deep discount bond) is a bond bought at a price lower than its

face value, with the face value repaid at the time of maturity.[1] It does not make periodic interest payments, or have socalled "coupons," hence the term zero-coupon bond. When the bond reaches maturity, its investor receives its par (or face) value. Examples of zero-coupon bonds include U.S. Treasury bills, U.S. savings bonds, long-term zero-coupon bonds,[1] and any type of coupon bond that has been stripped of its coupons. Definition of 'Deep-Discount Bond' 1. A bond that sells at a significant discount from par value. 2. A bond that is selling at a discount from par value and has a coupon rate + significantly less than the prevailing rates of fixed-income securities with a similar risk profile. Investopedia explains 'Deep-Discount Bond' 1. Typically, a deep-discount bond will have a market price of 20% or more below its face value. These bonds are perceived to be riskier than similar bonds and are thus priced accordingly. 2. These low-coupon bonds are typically long term and issued with call provisions. Investors are attracted to these discounted bonds because of their high return or minimal chance of being called before maturity. floating rate bond Definition Bond whose interest amount fluctuates in step with the market interest rates, or some other external measure. Price of floating rate bonds remains relatively stable because neither a capital gain nor a capital loss occurs as market interest rates go up or down. A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. In corporate finance, the term is used for a mediumto long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stockor note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although

the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital Basic concept: BONDS Understanding the price fluctuation of bonds is probably the most confusing part of this lesson. In fact, many new investors are surprised to learn that a bond's price changes on a daily basis, just like that of any other publicly-traded security. Up to this point, we've talked about bonds as if every investor holds them to maturity. It's true that if you do this you're guaranteed to get your principal back; however, a bond does not have to be held to maturity. At any time, a bond can be sold in the open market, where the price can fluctuate sometimes dramatically. We'll get to how price changes in a bit. First, we need to introduce the concept of yield. Measuring Return With Yield Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated using the following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield. Let's demonstrate this with an example. If you buy a bond with a 10% coupon at its $1,000 par value, the yield is 10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200). Yield To Maturity Of course, these matters are always more complicated in real life. When bond investors refer to yield, they are usually referring to yield to maturity (YTM). YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium). Knowing how to calculate YTM isn't important right now. In fact, the calculation is rather sophisticated and beyond the scope of this tutorial. The key

point here is that YTM is more accurate and enables you to compare bonds with different maturities and coupons. Putting It All Together: The Link Between Price And Yield The relationship of yield to price can be summarized as follows: when price goes up, yield goes down and vice versa. Technically, you'd you are a bond buyer, you want high yields. A buyer wants to pay $800 for the $1,000 bond, which gives the bond a high yield of 12.5%. On the other hand, if you already own a bond, you've locked in your interest rate, so you hope the price of the bond goes up. This way you can cash out by selling your bond in the future. say the bond's price and its yield are inversely related. Here's a commonly asked question: How can high yields and high prices both be good when they can't happen at the same time? The answer depends on your point of view. If

Price In The Market So far we've discussed the factors of face value, coupon, maturity, issuers and yield. All of these characteristics of a bond play a role in its price. However, the factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with newer bonds being issued with lower coupons In finance, the yield curve is a curve showing several yields or interest rates across different contract lengths (2 month, 2 year, 20 year, etc...) for a similar debt contract. The curve shows the relation between the (level of) interest rate (or cost of borrowing) and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph such as the one on the right which is informally called "the yield curve." More formal mathematical descriptions of this relation are often called the term

structure of interest rates. Normal yield curve From the post-Great Depression era to the present, the yield curve has usually been "normal" meaning that yields rise as maturity lengthens (i.e., the slope of the yield curve is positive). This positive slope reflects investor expectations for the economy to grow in the future and, importantly, for this growth to be associated with a greater expectation that inflation will rise in the future rather than fall. This expectation of higher inflation leads to expectations that the central bank will tighten monetary policy by raising short term interest rates in the future to slow economic growth and dampen inflationary pressure. It also creates a need for a risk premium associated with the uncertainty about the future rate of inflation and the risk this poses to the future value of cash flows. Investors price these risks into the yield curve by demanding higher yields for maturities further into the future. In a positively sloped yield curve, lenders profit from the passage of time since yields decrease as bonds get closer to maturity (as yield decreases, price increases); this is known asrolldown and is a significant component of profit in fixed-income investing (i.e., buying and selling, not necessarily holding to maturity), particularly if the investing is leveraged.[2] However, a positively sloped yield curve has not always been the norm. Through much of the 19th century and early 20th century the US economy experienced trend growth with persistent deflation, not inflation. During this period the yield curve was typically inverted, reflecting the fact that deflation made current cash flows less valuable than future cash flows. During this period of persistent deflation, a 'normal' yield curve was negatively sloped. Steep yield curve Historically, the 20-year Treasury bond yield has averaged approximately two percentage points above that of three-month Treasury bills. In situations when this gap increases (e.g. 20-year Treasury yield rises higher than the three-month Treasury yield), the economy is expected to improve quickly in the future. This type of curve can be seen at the beginning of an economic expansion (or after the end of a recession). Here, economic stagnation will have depressed shortterm interest rates; however, rates begin to rise once the demand for capital is re-established by growing economic activity. In January 2010, the gap between yields on two-year Treasury notes and 10year notes widened to 2.92 percentage points, its highest ever.

Flat or humped yield curve A flat yield curve is observed when all maturities have similar yields, whereas a humped curve results when short-term and long-term yields are equal and medium-term yields are higher than those of the short-term and long-term. A flat curve sends signals of uncertainty in the economy. This mixed signal can revert to a normal curve or could later result into an inverted curve. It cannot be explained by the Segmented Market theory discussed below. Inverted yield curve An inverted yield curve occurs when long-term yields fall below short-term yields. Why this would happen is that when lenders are seeking long-term debt contracts more aggressively than short-term debt contracts, lenders decrease the rate (the "cost of borrowing") in order to attract longer-term borrowing. See [3] People with extra money may use that cash to start a business or lend to a government treasury or buy things like real estate or stocks. When long-term lending to government treasuries is the preference of the wealthy for what to do with a particular amount of cash, then their willingness to make long-term loans to government treasuries produces a declining long-term yield which can invert the yield curve if short-term yields do not also come down (or if shortterm yields suddenly rise while long-term yields do not). Under unusual circumstances, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. Campbell R. Harvey's 1986 dissertation[4] showed that an inverted yield curve accurately forecasts U.S. recessions. An inverted curve has indicated a worsening economic situation in the future 6 out of 7 times since 1970.[5] The New York Federal Reserve regards it as a valuable forecasting tool in predicting recessions two to six quarters ahead. In addition to potentially signaling an economic decline, inverted yield curves also imply that the market believes inflation will remain low. This is because, even if there is a recession, a low bond yield will still be offset by low inflation. However, technical factors, such as a flight to quality or global economic or currency situations, may cause an increase in demand for bonds on the long end of the yield curve, causing long-term rates to fall. Since the Great Financial Crisis of 2007-2008, the U. S. Federal Reserve has maintained a ZIRP (zero interest rate policy) for an "extended period of time", where the short term interest rate is practically set to zero. Under this circumstance the nominal yield curve is unlikely to be inverted even in the

event of a recession. Thus the absence of an inverted yield curve is not a sufficient condition to preclude recessions.

Why do interest rates tend to have an inverse relationship with bond prices?
At first glance, the inverse relationship between interest rates and bond prices seems somewhat illogical, but upon closer examination, it makes sense. An easy way to grasp why bond prices move opposite to interest rates is to consider zero-coupon bonds, which don't pay coupons but derive their value from the difference between the purchase price and the par value paid at maturity. For instance, if a zero-coupon bond is trading at $950 and has a par value of $1,000 (paid at maturity in one year), the bond's rate of return at the present time is approximately 5.26% ((1000-950) / 950 = 5.26%). For a person to pay $950 for this bond, he or she must be happy with receiving a 5.26% return. But his or her satisfaction with this return depends on what else is happening in the bond market. Bond investors, like all investors, typically try to get the best return possible. If current interest rateswere to rise, giving newly issued bonds a yield of 10%, then the zero-coupon bond yielding 5.26% would not only be less attractive, it wouldn't be in demand at all. Who wants a 5.26% yield when they can get 10%? To attract demand, the price of the pre-existing zero-coupon bond would have to decrease enough to match the same return yielded by prevailing interest rates. In this instance, the bond's price would drop from $950 (which gives a 5.26% yield) to $909 (which gives a 10% yield).

The Link Between Interest Rates and Maturity Changes in interest rates don't affect all bonds equally. The longer it takes for a bond to mature, the greater the risk that prices will fluctuate along the way and that the fluctuations will be greater-and the more the investors will expect to be compensated for taking the extra risk. There is a direct link between maturity and yield. It can best be seen by drawing a line between the yields available on like securities of different maturities, from shortest to longest. Such a line is called a yield curve. A yield curve could be drawn for any bond market but it is most commonly drawn for the Government market, which offers securities of every maturity, and where all issues bear the same top credit quality.

By watching the yield curve, you can gain a sense of where the market perceives interest rates to be headed-one of the important factors that could affect your bonds' prices. A normal yield curve would show a fairly steep rise in yields between shortand intermediate-term issues and a less pronounced rise between intermediateand long-term issues. That is as it should be, since the longer the investor's money is at risk, the more the investor should expect to earn. If the yield curve is said to be "steep," it means the yields on short-term securities are relatively low when compared to long-term issues. This means you can obtain significantly increased bond income (yield) by buying a longer maturity than you can with a short one, and you may wish to modify your choice of bond accordingly. On the other hand, if the yield curve is "flat," it means the difference between short- and long-term rates is relatively small. This means that the reward for extending maturities is relatively small, and many investors will choose to stay in the short end of the maturity range. When yields on short-term issues are higher than those on longer-term issues, the yield curve is said to be "inverted." This suggests that investors expect interest rates to decline. An inverted yield curve is sometimes considered to be a harbinger of recession.

The Interest Rate-Inflation Connection As an investor, you need to know how bond market prices are directly linked to economic cycles and concerns about inflation. You may have wondered why press reports say the bond market fell after the government released positive economic news about job growth or housing starts. As a general rule, the bond market, and the overall economy, benefit from steady, sustainable growth rates. Moderate economic growth also benefits the financial strength of the government, municipal and corporate issuers whose bonds you may hold, making them a stronger credit. But steep rises in economic growth can lead to inflation, which raises the costs of goods and services for everyone, leads to higher interest rates and erodes a bond's value. Ultimately, persistent and rapid economic growth will lead to rising interest rates, either through actions taken by the Federal Reserve to slow

the expansion, or through market forces acting in anticipation of interest rate moves. Since rising interest rates push bond prices down, the bond market tends to react negatively to reports about strong economic growth. Assessing Risk Virtually all investments have some degree of risk. When investing in bonds, it's important to remember that an investment's return is linked to its risk. The higher the return, the higher the risk. Conversely, relatively safe investments offer relatively lower returns.

Definition of 'Retractable Bond' A bond that features an option for the holder to force the issuer to redeem the bond before maturity at par value. An investor may choose to shorten the maturity on a bond because of market conditions or if he or she requires the principal sooner than expected. Investopedia explains 'Retractable Bond' For example, a company might issue 20-year retractable bonds to the market. This means the investor who buys the bond from the issuer has the right to receive the par value or face value of the bond at any time before maturity. If the investor exercises the right to retract, then he or she will forgo the rest of the coupon payments on the bond. An investor might exercise this option due to unfavorable market conditions such as a rise in interest rates. An increase in interest rates would translate into lower bond prices. As a result, investors may want to switch to higher-yielding bonds. Definition of 'Asset-Backed Security - ABS' A financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt.

Investopedia explains 'Asset-Backed Security - ABS' An ABS is essentially the same thing as a mortgage-backed security, except that the securities backing it are assets such as loans, leases, credit card debt, a company's receivables, royalties and so on, and not mortgage-based securities.

Definition of 'Foreign Currency Convertible Bond - FCCB' A type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. Investopedia explains 'Foreign Currency Convertible Bond FCCB' These types of bonds are attractive to both investors and issuers. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. (Bondholders take advantage of this appreciation by means warrants attached to the bonds, which are activated when the price of the stock reaches a certain point.) Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs. Inflation-indexed bonds (also known as inflation-linked bonds or colloquially as linkers) are bondswhere the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment.[1] The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780.[2] The market has grown dramatically since the British government began issuing inflation-linkedGilts in 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the international debt market.[3] The inflation-linked market primarily consists

of sovereign bonds, with privately issued inflation-linked bonds constituting a small portion of the market.

Definition of 'Mortgage-Backed Security (MBS)' A type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution. Also known as a "mortgage-related security" or a "mortgage pass through." Investopedia explains 'Mortgage-Backed Security (MBS)' When you invest in a mortgage-backed security you are essentially lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to worry about whether the customers have the assets to cover the loan. Instead, the bank acts as a middleman between the home buyer and the investment markets. This type of security is also commonly used to redirect the interest and principal payments from the pool of mortgages to shareholders. These payments can be further broken down into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.