Treasury Securities

Treasury securities, or simply Treasuries, are issued by the U.S. Treasury. They are considered to be risk free as they are backed by the U.S. government. There are four  types of treasury securities: Treasury bills (T-Bills) have maturities of less than 1 year. Like a zero-coupon bond, they only pay par value at the maturity […]

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Credit risk /Default risk and bond rating

The credit risk or default risk is the risk of an issuer not making timely interest or principal payments as promised. Bonds issued by the US federal government have nearly zero default risk while corporations have risk of being unable to meet payments (and default on their debts). Since the standard investor is risk-averse, the […]

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Interest Rate Risk and Duration

Interest rate risk is the sensitivity of a bond’s value to variability of market interest rates/yields. In general, as interest rates increase, bond prices decrease (and vice versa). A bond’s duration is the number of years it takes for a bond to pay out its original cost by its internal cash flows and is the […]

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Yield to Maturity, Nominal Yields, and Current Yields

A Yield is a rate that shows the return you get on a bond. The basic yield formula is: yield = coupon amount / price. There are a few kinds of yield related to bonds; when investors or analysts refer to yield, they usually mean the yield to maturity (YTM). YTM measures the annual return earned […]

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Embedded Options in Bonds

An embedded option is a component of the bond contract and grants the holder or the issuer certain rights to dispose of or redeem a bond. It cannot be separated from the bond and therefore does not trade by itself. A bond with security holder options (which benefit the holders) has additional value and therefore […]

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How to do a Company Valuation

There are several analytical methods commonly used in valuation. The financial theories behind these methods were developed over several years of research and enhancement by the biggest names in finance and financial economics. Valuation, however, is an art and not a science. These methods are only a framework, and inputs into these frameworks are critical […]

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Coupon Rate Structure of Bonds

A Coupon is the payment that the bond issuer pays the bond holder at certain frequency. Normally the coupon is paid semi-annually or annually.  Some of the most common types of Bonds based on their coupon rate structures are: 1)      Fixed Rate Bonds have a constant coupon rate throughout the life of the bond. For […]

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The Risk Free Rate

The risk-free rate is the theoretical rate of return of a risk-free asset. It is one of the basic components of modern finance. Many famous valuation models are derived from the risk-free rate: Capital Asset Pricing Model (CAPM), Black-Sholes model, etc. In reality, it does not exist because even the safest investments have certain amount […]

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Discount Rates, Required Rate of Return and Effective Annual Rates

The interest rate at which cash flows are discounted is referred to as the discount rate. The equilibrium discount rate is the required rate of return for a particular investment, which means the present value (PV) of the future cash flows discounted at the equilibrium discount rate should be equal to the amount of money […]

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Introduction to the Time Value of Money

The time value of money concept is the basis of finance theory.  It is the idea that money now is worth more than the same amount of money in the future. The process of finding the present Value (PV) of a future cash flow is called discounting, and the interest rate at which we discount […]

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