Preface xix
Chapter 1 Getting to the starting point 1
Bonds: important for you 1
A simple product 2
Interest rates 4
A big market 5
Relevant for equity investors 5
Bonds: important for everyone 6
Bonds and the global economy 9
Bonds and equities: showing the value in bonds 10
A summary to finish the first chapter 13
Notes 14
Chapter 2 Bond basics 17
Description 17
Type of issuer 19
Term to maturity 19
Principal and coupon rate 19
Currency 20
Bond issuers 20
Types of bonds 22
Conventional bonds 22
Government bonds 22
Floating rate notes 23
Index-linked bonds 23
Zero-coupon bonds 23
Corporate bonds 23
High yield bonds 24
Eurobonds 24
Bonds with embedded options 24
Bond warrants 24Asset-backed securities 25
The queasy stuff: price and yield 25
Financial arithmetic 25
Pricing bonds 28
Bond yields 31
More queasy stuff: a (thankfully!) brief word on duration 39
Revisiting the bond price/yield relationship 39
Duration 40
Properties of duration 43
Appendix 2.1: Using Microsoft Excel® to calculate
bond yield and duration 44
Notes 46
Chapter 3 The UK gilt market 47
Introduction and history 48
Market instruments 49
Conventional gilts 49
Index-linked gilts 50
Double-dated gilts 52
Floating rate gilts 53
Gilt strips 53
Undated gilts 53
Treasury bills 54
Maturity breakdown of stock outstanding 54
Market trading conventions 54
Investing in gilts 55
Taxation 56
Resident private investors 56
Overseas investors 57
Market structure 57
Market makers 57
The role of the Bank of England 59
Issuing gilts 59
Auction procedure 61
Conversions 63
Gilt strips 64
Market mechanics 64
Pricing convention 65
Interest rate risk for strips 66
Usefulness for private investors 66
Appendix 3.1: List of gilt stocks outstanding,
30 September 2005 67
Appendix 3.2: Related gilt market websites 69
Notes 69Chapter 4 Investing in non-UK government bonds 71
Overview of government markets 71
The primary market in government bonds 71
The secondary market in government bonds 74
Germany 74
Introduction 74
Volumes and issuance 75
Market structure 76
Italy 78
Market structure 79
Primary and secondary markets 80
France 81
The primary market 81
The secondary market 83
OAT strips 84
Euro-zone information sources 84
The US Treasury market 85
Introduction 85
Treasury dealing by private investors 85
Notes 86
Chapter 5 Corporate bonds, Eurobonds and credit quality 87
Corporate bonds 88
Introduction 88
Basic provisions 90
The primary market 91
The secondary market 93
Fundamentals of corporate bonds 93
Bond security 95
Call and refund provisions 95
PIBS: a sterling investor’s favourite 96
Corporate bond risks 97
Credit risk 99
Liquidity risk 100
Call risk 100
Event risk 101
High yield corporate bonds 102
Eurobonds 103
Basic structure 103
Floating rate notes 104
Zero-coupon bonds 105
Credit ratings 105
Some basics 106
Notes 108Chapter 6 Understanding and appreciating the yield curve 111
Introduction 111
What is the yield curve? 112
Using the yield curve 114
Setting the yield for all debt market instruments 114
Acting as an indicator of future yield levels 115
Measuring and comparing returns across the maturity
spectrum 115
Indicating relative value between different bonds of
similar maturity 115
Pricing interest-rate derivative instruments 115
Yield to maturity yield curve 116
Yield curve shapes 116
Now the caveat 116
Analysing and interpreting the yield curve 118
Theories of the yield curve 119
The expectations hypothesis 119
Liquidity preference theory 122
Segmentation hypothesis 123
Humped yield curves 125
The flat yield curve 125
Further views on the yield curve 126
Using the yield curve as a private investor 129
Appendix 6.1:The zero-coupon yield curve 130
A hairy bit 133
Notes 135
References 136
Chapter 7 Dealing for the private investor 137
Dealing in bonds 137
Dealing language 137
Dealing mechanics 138
Stockbrokers 138
Types of stockbroker 138
Choosing a broker 140
Picking suitable bonds 140
Income versus capital gain 142
Taxation issues 142
Notes 143
Glossary 145
Further reading 163
Useful websites 165