ABC Airlines needs £50 million to re-equip and update its online booking system. One board member suggested borrowing the £50 million from a bank.

‘Sales are down a bit at the moment,’ the financial director said. ‘We are not looking as prosperous as we have in the past. The bank would charge a very high interest rate.’

‘What about floating a share option and selling more shares in the company?’ someone else suggested. ‘That would bring in plenty of cash.’

The chairman looked grumpy. ‘It would bring in a lot of new share holders too,’ he said. ‘Too many people think they run this company already.’

‘We could issue a bond,’ someone else suggested. ‘That would bring in money, but it would be cash without any interference from the bond holders.’

And that is what they did.

In this chapter, we shall describe various bonds. We will show how to find the value of a bond and why the value of a bond might change. We will show how to measure the yield of a bond and how to compare two (or more) apparently very different bonds. Finally, we show how known bond prices can be used to construct a zero curve.

Bonds

When an organisation issues a bond, it is promising to make a sequence of predetermined payments to the owner of the bond. The bond will have a principal or a face value (e.g. $100 or £1000) and a maturity (e.g. one year, five years, ten years).We shall consider two types of bond.