ABSTRACT
If we buy a bond we are loaning money to a corporation. The corporation is obligated to pay back the principal, called the face value, and promises to pay a stream of certain payments, called coupons. Hence we receive a ¯xed stream of income. Thus bonds are called ¯xed-income securities. Although bonds seem to be risk-free, they are not so. Our income from the bond is guaranteed only if we keep the bond to maturity. If we sell the bond before maturity, our return will depend on changes in the price of the bond. Bond prices vary in the opposite direction to interest rates. Although the interest rate of our bond is ¯xed, that in the cash market varies. Therefore, the price of our bond in the cash market varies.
