6.9: Key Terms

This section provides concise definitions of key financial terms introduced in this chapter. These definitions are presented in a static, printable format for reference and exam preparation. When viewed online, additional dynamic highlighting of terms may be available.

Term	Definition
Basis point (bp)	One hundredth of one percent (\(0.01\%\)). Basis points are used to express yield differences and credit spreads precisely (e.g., 0.85% = 85 bps).
Bond	A debt contract in which an issuer borrows funds from investors (bondholders) and promises periodic interest payments (coupons) plus repayment of principal (par value) at maturity.
Bond-equivalent yield (BEY)	A quoted annual yield for securities with semiannual compounding. Under BEY conventions, the periodic rate is \(y/2\) and the number of periods is \(2N\).
Call price	The price (often slightly above par) at which a callable bond can be redeemed by the issuer before maturity.
Callable bond	A bond that gives the issuer the right (but not the obligation) to redeem the bond before maturity at a specified call price. Callability increases reinvestment risk for investors and typically requires a higher yield.
Cash flow timeline	A visual schedule of when bond cash flows occur (coupon payments each period and par value at maturity). Timelines reduce setup errors in TVM, calculator, and spreadsheet valuation.
Convexity	A measure of the curvature in the bond price–yield relationship. Convexity improves duration-based price change estimates, especially when yield changes are large.
Coupon (coupon payment)	The periodic interest payment on a bond. For a bond with par value \(F\), coupon rate \(c\), and \(m\) payments per year, the periodic coupon is \(C = F\cdot c/m\).
Coupon rate	The stated annual interest rate on a bond, expressed as a percentage of par value. The coupon rate determines the size of coupon payments but does not equal the bond’s yield unless the bond trades at par.
Coupon frequency	How often a bond pays coupons (annual, semiannual, quarterly, etc.). U.S. corporate and Treasury coupon bonds commonly pay semiannually, so valuation uses \(y/2\) and \(2N\) periods.
Credit rating	An assessment of an issuer’s default risk provided by rating agencies (e.g., S&P, Moody’s, Fitch). Higher ratings generally imply lower required yields and narrower credit spreads.
Credit risk (default risk)	The risk that an issuer will fail to make promised coupon or principal payments. Higher credit risk requires higher yields and lowers bond prices.
Credit spread (yield spread)	The difference between a risky bond’s yield and the yield on a comparable Treasury bond of similar maturity. Spreads compensate for credit risk and often liquidity risk; spreads are commonly stated in basis points.
Current yield (CY)	Annual coupon divided by current market price: \(CY = \text{Annual Coupon}/P\). Current yield measures income relative to price but ignores time value and any capital gain or loss at maturity.

Term	Definition
Discount rate (required yield)	The market rate used to discount a bond’s cash flows. In bond valuation, this required return reflects prevailing interest rates, maturity, and risk (including credit and liquidity conditions).
Duration	A measure of interest-rate sensitivity based on the timing of a bond’s cash flows. Higher duration implies larger price changes for a given change in yield (all else equal).
Embedded option	A feature in a bond that gives either the issuer or investor an option-like right (e.g., callability, putability). Embedded options affect expected cash flows and required yields.
Face value (par value, principal)	The amount repaid at maturity, commonly \(F = 1000\) for corporate bonds. Par value is also the base used to compute coupon payments.
Indenture	The legal bond contract that defines coupon terms, maturity, covenants, collateral provisions, and bondholder rights.
Interest-rate risk	The risk that bond prices will change due to changes in market interest rates. Interest-rate risk increases with longer maturities and lower coupon rates and is summarized by duration and convexity.
Liquidity risk	The risk that a bond cannot be traded quickly at a fair price. Less liquid bonds typically require higher yields (wider spreads) to compensate investors.
Macaulay duration	The weighted average time to receive a bond’s cash flows, where weights are the present value of each cash flow divided by price. It is expressed in years (or periods) and summarizes cash-flow timing.
Maturity	The date when a bond’s principal is repaid. Longer maturities generally increase exposure to interest-rate risk and make bond prices more sensitive to yield changes.
Modified duration	A duration measure that approximates percentage price change for a small change in yield: \(\Delta P/P \approx -D_{Mod}\Delta y\). It converts Macaulay duration into a sensitivity measure.
Price	The market value of a bond today. Bond prices are determined by discounting expected cash flows at the required yield; prices rise when yields fall and fall when yields rise.
Putable bond	A bond that gives the investor the right to sell the bond back to the issuer at specified dates and prices. Putability reduces downside risk for investors and typically lowers required yield.
Tax-equivalent yield (TEY)	The taxable yield that makes an investor indifferent between a tax-exempt municipal yield and a taxable bond yield: \(TEY = y_{muni}/(1-T)\), where \(T\) is the marginal tax rate.
Treasury benchmark	U.S. Treasury yields used as the reference “risk-free” term structure for pricing other bonds. Spreads over Treasuries are commonly used to isolate credit and liquidity risk.
Yield	A measure of return based on a bond’s price and promised cash flows. Yields are quoted as annual rates, but pricing requires consistency between the yield’s compounding frequency and the number of periods.
Yield curve	A graph of yields on default-free (or Treasury) bonds across maturities. The yield curve summarizes the term structure of interest rates and reflects expectations about future rates, inflation, and economic conditions.
Yield to call (YTC)	The yield calculated assuming the bond is called at the earliest call date and redeemed at the call price. YTC is most relevant when a bond trades at a premium and call is likely.
Yield to maturity (YTM)	The single discount rate that equates the present value of all promised cash flows to the bond’s current price (assuming coupons are reinvested at the same rate and the bond is held to maturity).
Zero-coupon bond	A bond that pays no coupons and is issued at a discount, returning par value at maturity. Because all cash flow occurs at the end, zero-coupon bonds have high duration and high interest-rate sensitivity.

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