Chapter 1. The Gravity of Finance: Bond Pricing and Yields

Bonds are the backbone of the global financial system. While stocks represent hope and growth, bonds represent ==“Debt and Probability.”== To master advanced bonds, one must first understand the fundamental law of the bond world: The Seesaw of Price and Yield.

1. The Inverse Relationship: The Seesaw

The most important rule in fixed income is that price and interest rates move in opposite directions.

The Bond Price Seesaw

Market Interest Rate	Bond Price	Explanation
Rising ↑	Falling ↓	Existing bonds with lower coupons become less attractive.
Falling ↓	Rising ↑	Existing bonds with higher coupons become more valuable.
Stable →	Stable →	Price stays close to par if the coupon matches the market.

2. Advanced Valuation: Discounted Cash Flow (DCF)

The price of a bond is simply the Present Value (PV) of all its future cash flows (coupons + principal repayment).

Cash Flow Map

Identify the timing and amount of all future coupon payments and the final face value

Discounting

Apply the market discount rate (YTM) to each future payment

Summation

Add up all the present values to find the current 'Fair Price'

Comparison

Compare the fair price with the market price to find 'Cheap' or 'Rich' opportunities

3. Understanding Yield to Maturity (YTM)

YTM is the most widely used measure of a bond’s return. It is the internal rate of return (IRR) an investor will receive if they hold the bond until maturity and all payments are made on time.

==“The Expected Return”==: YTM assumes that all coupon payments are reinvested at the same rate.
Current Yield vs. YTM: Current yield only looks at the annual interest. YTM looks at the entire journey, including the gain or loss on the price relative to the face value.

Note

The Pull to Par: As a bond approaches its maturity date, its market price will naturally move closer to its face value ($1,000 in most cases), regardless of whether it was trading at a discount or a premium.

4. Conclusion: Understanding the Core

Bond pricing is not just a formula; it is the manifestation of the ==“Time Value of Money.”== By mastering how interest rates pull and push bond prices, you gain the ability to navigate the largest and most complex market in the world.

📚 Prof. Sean’s Selected Library

[Bond Markets, Analysis, and Strategies] - Frank Fabozzi: The “Bible” of bond investing.
[Fixed Income Analysis] - CFA Institute: A comprehensive and rigorous guide to bond valuation and risk.
[Interest Rate Markets] - Siddhartha Jha: A practical look at how interest rate movements drive bond returns.

Next time, we will explore ‘Duration and Convexity’—learning how to measure exactly how sensitive a bond is to a 1% change in interest rates.