The Nordic Crisis of 1992
The Nordic crisis of 1992 refers to the series of bank runs and currency crisis that shook Finland, Sweden as well as Norway in the early 1990’s. This was the first major national banking crisis since the 1930’s (if wars are not taken into account). Thus, an important belief that the fractional reserve banking system […]
Pension Funds and the Use of Derivatives
Pension funds across the world are meant to be low-risk financial instruments. They are allowed to take slightly more risks in some parts of the world as compared to others. However, for the most part, pension fund across the world is advised to stay away from risky instruments such as derivatives. Derivatives have been known […]
Impact Investing: Where Profit Meets Social Responsibility
Finance as a force for good Even before the 2008 global financial meltdown, finance worldwide was not exactly successful at deflecting its reputation for greed and excess. But something has been happening on the periphery and is now very much at the core of the financial world; one that proves investing can generate both profitable […]
The Story Behind the L&T- Mindtree Takeover Bid
The Indian stock market is abuzz with the news of a hostile takeover. Larsen and Toubro, which is one of the largest and the most iconic information technology firms in the country is trying to forcefully acquire Mindtree which is a medium-sized information technology company. The news is abuzz about how Mindtree promoters do not […]
Examples of Exchange Traded Derivatives
In the previous article, we studied about exchange traded derivatives. We studied their defining features and found out the reason behind their popularity. However, exchange traded derivatives are of many types. They are traded all over the world in different stock exchanges. Hence, there are many different types of exchange traded derivatives. In this article, […]
While calculating present values of bonds, one may observe that some of the information required to compute the present value is actually missing from the question. However, this is not an error. One needs to understand that the examiner is in a way testing your knowledge of how the bond market works. In the bond market, some of the information is considered to be implied i.e. it is not explicitly communicated. This is called the bond market convention. Here is a list of some of the commonly used conventions in the bond market:
Face Value Convention: If the face value of the bond is explicitly given, then the explicit face value must be used. However, if the face value is not explicitly given then the implied value is either $100 or $1000. Students can choose any of these values as the face values. They may state this in their assumptions for deriving the solution. But that too may not be required because bond market convention dictates that these values must be considered the face value in the absence of appropriate data.
Interest Rates Are Semi-Annual: Once again, a student needs to check if the frequency of the interest rates has been explicitly mentioned. In case it is, then we must use the interest rates that correspond to the frequency. However, in case they are not given, we need to use semi-annual interest rates. Most bond markets across the world pay interest twice a year. Hence, it is a reasonable assumption to make. Changing the annual interest rate into a semi-annual one has a huge change on the present value of the bond.
Day Count Conventions: Day count conventions specify the number of days that a year contains according to the bond market. The number of days in a year is important to the calculation of the interest that has been accrued on the bond. The day count convention, however, is not uniform in bond markets across the world. Each market has its own convention and the trader must be aware of the type of convention being used in the specific market that they are concerned about. However, day count conventions can be broadly classified into 3 categories:
Interest Payments: Another convention that we need to discuss about is when the interest payment actually gets made. Now, once again this depends on the specific bond that is being considered. However, there are terms like EOM which denote that interest will be paid at the end of every month. Any student of bond valuation must be well versed with these terms as well as the implications that using these terms has on the valuation of the bond.
This list of conventions is obviously not comprehensive. There are many more conventions that may apply to all the markets across the globe or maybe specific to a given market. However, this article was meant to indicate that sometimes there might be information implied in the question even though one does not explicitly see the information mentioned.
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