INTRODUCTION

A bond is a financial instrument that establishes a relationship between the purchaser (creditor) and the issuer (debtor). It is a promise to pay a certain amount of money by the issuer to the purchaser each period until a certain date, at which point the principal is also returned. Thus, a bond is a particular type of constant earning security.

The next section of this chapter presents a short discussion on the discounted present value of a constant earning scheme. Issues related to bonds are analyzed in detail in Sections 7.3–7.7. These sections cover bond pricing, yield curves, duration and the convexity of bonds, and use of a bond portfolio for immunization of interest rate risk. Section 7.8 deals with forward interest rate, the rate of interest for a future period implied by the interest rates existing currently. The concern of Section 7.9 is the forward rate agreement, an agreement indicating that a particular rate of interest will be effective on a certain principal amount at a certain period of time in the future.