Fixed rate bond

As standard bonds (also: coupon bonds, fixed-rate loan, fixed rate notes, straight bonds, plain vanilla bonds) are called bonds with fixed nominal interest rate that is paid in arrears and annually, semi-annually or quarterly basis due. These are the most common bonds.

The coupon ( = nominal interest rate ) of standard bonds is usually different from the market interest rate. This can have the following reasons:

• The market interest rate has changed since issuance of the bonds.
• The market rate was out of round, a round in the interest coupons therefore a different from the market rate of interest was selected. Example: market interest rate is 2.85%, one chooses a coupon of 3%.
• It is deep-discount bonds, which were deliberately issued under par.

Assessment

In which

• K = Coupon
• R = ( term independent ) market interest rate
• N = maturity in years

Yield to Maturity ( effective interest rate )

The effective interest rate ( yield to maturity, YTM ) is calculated by discounting the future cash flows (coupon and principal amount ) with a uniform discount rate. Result of discounting is today's exchange rate.

Problems

The effective interest rate is, however, of limited use for comparison of bonds.

• For many bonds the effective interest rate can not even be calculated.
• Additional problems arise with respect to the remaining term: In a free residual maturity, the reinvestment assumption is necessary in order to compare any two lending facilities can, otherwise, the bond with the highest residual maturity automatically the highest effective interest rate.
• For a given residual maturity relative over - and under-valuations in the market does not depend on a comparison variable. By linear combination of instruments can possibly a higher effective interest rate can be achieved.

Review with less than one year interest payments

Find the coupon payment does not take place every year, but, for example, semi-annually or quarterly, so the interest periods and market rate must be adapted accordingly, because a compounding effect must be taken into account for the year paid coupons. Alternatively, you can also adjust the annual coupon so that the effect of compound interest is calculated into the interest rate.

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• Interest-bearing securities