The price of bonds

Are you looking at this article feeling puzzled? Aren't bond prices clearly stated in the product manual? Can't they just stay the same? Congratulations, it seems that you have had a great awakening in terms of product manuals.

But this is still at the theoretical stage. In theory, the face value of bonds is supposed to be their price. However, in actual practice, due to factors such as market supply and demand, market interest rates, the market price of bonds often deviates from their face value. In other words, the face value of bonds is fixed, but their price changes frequently.

So, what mysterious forces specifically influence bond prices? In Futubull's mind, various factions instantly emerge - nominal interest rate, profit expectations, maturity period, credit rating, economic and inflation outlook, supply and demand, future monetary policy, risk preferences, speculative factors... The complexity is enough to discourage any enthusiasm for learning.

However, in reality, the biggest force driving changes in bond prices comes from changes in market interest rates. Generally speaking, there is an inverse relationship between interest rates and bond prices - when market interest rates rise, existing bond prices fall; conversely, when market interest rates decrease, existing bond prices rise.

This seems not very easy to understand, so Futubull once again sacrifices itself to be a scapegoat bull to help everyone understand.

1) Net buy/sell prices

Without considering accrued interest, the market price of bonds. The price provided by each market maker may vary. For example, Evergrande bonds:

Buy price: $96.711 usd refers to the price at which customers buy bonds from market makers.
Sell price: $97.795 usd refers to the price at which customers sell bonds to market makers.

It is important to emphasize that the buy/sell prices here are just reference prices. Since bonds are traded over-the-counter (OTC), placing orders based on reference prices does not guarantee execution. Patience is needed to wait for counterparties willing to transact at these prices.

Futubull bought a one-year corporate bond with a face value of 100 yuan and an interest rate of 5% at the beginning of the year, while the bank deposit rate was 3% at that time. One year later, Futubull will be able to receive 105 yuan with both principal and interest.

One month later, Futubull suddenly needed the 100 yuan and wanted to sell the bond. However, at that time, the bank interest rate had risen to 5%. The returns on banks and bonds were similar, so no one was willing to take on the risk and acquire Futubull's bond.

In a hurry to sell, Futubull had to sell at a low price.

As a result, with the increase in interest rates, the bond price actually decreased.

Originally thought that a decrease in interest rates was not a good thing, because the yields of traditional financial products would all decrease as a result, but in the bond market, it was quite the opposite.

Surely, there is a magical power in the bond market...

2) Accrued Interest

If A sells the bond to B, B will receive the full amount of the next period's interest, so B needs to pay accrued interest to A.

3) buy full price / sell full price

Buying full price / Selling full price = Buying net price / Selling net price + Accrued interest

Sell the full price: The price you buy bonds from the bank, including accrued interest. Multiply this price by the principal plus fees, that is the money you need to pay to buy the bonds.

When holding bonds, each interest received equals the compensation for the period of holding.

For example, bonds issued by Baidu, with an interest rate of 3.62%, paying dividends twice a year, distributing dividends every six months.

The last dividend payment was on July 6, 2020, the next one is on January 6, 2021, assuming a transaction on September 6.

Therefore, a person who buys the bond on September 6 will receive the complete semi-annual dividend on the next dividend payment date, which is January 6, 2021.

However, during the period from July 6 to September 6, the bond was held by the previous investor, who should receive the dividend amount for those two months.

Therefore, when this bond is traded on September 6, the buyer must first pay the seller the interest for those two months, which is the accrued interest.

Accrued interest = Nominal annual interest rate * 100/2 * actual number of days from the commencement date to the settlement date / actual number of days from the commencement date to the maturity date.

Assuming buying this bond for 100 yuan today at a price of 110 (buying net price), then:

Accrued interest = 100 * 3.62% / 2 * 60 / 180 = 0.6033 yuan

Buying full price = 110 + 0.6033 = 110.603 yuan.