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Hello
I have a little confusion understanding of coupon rate attached to the bond say 100 .if the coupon rate is ,5% it means annual interest payments are 5 ..then there is a concept of yield to maturity for e.g 6% ..so this is the rate of return that we are expected to receive on our bond on redemption .
How I should interpret the above we are paying 5 each year for holding the bond or receiving 5 ???
How I should interpret redemption yield in theory ..why are we using it as a discount factor ?
I read the text book and related bond article …I got confusion in this above point ..please clarify
The coupon rate is the interest on nominal. So if the bonds have a nominal value of $100 and a coupon rate of 5%, then the interest will indeed be $5 per year.
However the market value of the bond is the present value of the future expected receipts (i.e. $5 interest per year and the repayment on redemption) discounted at the investors required rate of return (which is the same as the actual yield (return) that the investor will actually be getting).
So if we want to know the return that investors are actually getting (the yield to maturity) we need to calculate the IRR i.e. the rate of interest that makes the PV of the future receipts equal to the current market value.
I do suggest that you watch my free lectures on this (and if necessary the relevant Paper F9 lectures, because this bit is revision of F9).
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