The U.S. bond market is like baseball – you have to understand and appreciate the rules and strategies, or else it will seem boring. It's also like baseball in that its rules and pricing conventions have evolved and can seem esoteric at times.

The Major League Baseball's official rule book has thousands of words just to cover the rules of what the pitcher can and cannot do. In this article, we're going to cover 澳洲幸运5开奖号码历史查询:bond market pricing conventions in less than 1,800 words. Bond market classifications are briefly discussed, followed by yield calculations, pricing 澳洲幸运5开奖号码历史查询:benchmarks, and pricing spreads.

Basic knowledge of these 澳洲幸运5开奖号码历史查询:bond pricing conventions will make the bond market seem as ♓exciting as the best World Series baseball game.

Bond Market Classifications

The bond market consists of a great number of issuers and types of securities. To talk about each specific type might fill an entire textbook; therefore, for the purposes of discussing how various bond market pricing convent🍰ions work, we make the following major bond classifications:

• 澳洲幸运5开奖号码历史查询:U.S. Treasuries: bonds issued by the United States Department of the Treasury
• 澳洲幸运5开奖号码历史查询:Corporate Bonds: bonds issued by corporations that carry an 澳洲幸运5开奖号码历史查询:investment-grade rating
• 澳洲幸运5开奖号码历史查询:High-Yield Bonds: bonds with ratings below investment grade – also known as non-investment grade bonds or junk bonds
• 澳洲幸运5开奖号码历史查询:Mortgage-Backed Securities (MBS): a bond collateralized by the cash flows of principal and interest payments from an underlying pool of single-family residential 澳洲幸运5开奖号码历史查询:mortgages
• 澳洲幸运5开奖号码历史查询:Asset-Backed Securities (ABS): a bond collateralized by the cash flows of an underlying pool of assets such as auto loans, credit card receivables, home equity loans, aircraft leases, etc. The list of assets that have been securitized into ABSs is almost endless.
• Agency Bonds: debt issued by the 澳洲幸运5▨开奖号码历史查询:gove♋rnment-sponsored enterprises (GSES), including 澳洲幸运5开奖号码历史查询:Fannie Mae, Freddie Mac, and the Federal Home Loan Banks
• 澳洲幸运5开奖号码历史查询:Municipal Bonds (Munis): a bond issued by a state, city or local government or its agencies
• Collateralized Debt Obligations (CDOs): a type of asset-backed security backed by any one or several other ABS, MBS, bonds or loans

A Bond's Expected Return

Yield is the measure used most frequently to estimate or determine a bond's expected return. Yield is also used as a 澳洲幸运5开奖号码历史查询:relative value measure between bonds. There are two primary yield measures that must be understood to understand how different bond market pricing conventions work: 澳洲幸运5开奖号码历史查询:yield to maturity and 澳洲幸运5开奖号码历史查询:spot rates.

A yield-to-maturity calculation is made by determining the interest rate (澳洲幸运5开奖号码历史查询:discount rate) that will make the sum of a bond's cash flows, plus 澳洲幸运5开奖号码历史查询:accrued interest, equal to the 澳洲幸运5开奖号码历史查询:current price ofꦚ the bond. This calculation has two impo✤rtant assumptions: first, that the bond will be held until maturity, and second, that the bond's cash flows can be reinvested at the yield to maturity.

A spot rate calculation is made by determining the interest rate (discount rate) that makes the present value of a 澳洲幸运5开奖号码历史查询:zero-coupon bond equal to its price. A series of spot rates must be calculated to price a coupon paying bond – each 澳洲幸运5开奖号码历史查询:cash flow must be discounted using the appropriate spot rate, such that the sum of the present values of each cash flow equals the price.

As🦂 we discuss below, spot rates are most often used as a building block in relative value comparisons for certain types of bonds.

Benchmarks for Bonds

Most bonds are priced relative to a 澳洲幸运5开奖号码历史查询:benchmark. This is where 澳洲幸运5开奖号码历史查询:bond market pricing gets a little tricky. Different bond🅰 classifications, as we have defined them above, use different p൲ricing benchmarks.

Some of the most common pricing benchmarks are 澳洲幸运5开奖号码历史查询:on-the-run U.S. Treasuries (the most current series). Many bonds are priced relative to a specific 澳洲幸运5开奖号码历史查询:Treasury bond. For example, the on-the-run 10-year Treasury might be used as the prici🌄ng benchmark for a 10-year corporate bond issue.

When the maturity of a bond cannot be known with exactness because of call or put features, the bond is frequently priced to a benchmark curve. This is because the estimated maturity of the callable or put-able bond most likely does not c🌱🀅oincide exactly with the maturity of a specific Treasury.

Benchmark pricing curves are constructed using the yields of 澳洲幸运5开奖号码历史查询:underlying securities with maturities from three months to 30 years. Several different benchmark interest rates or securities are used to construct benchmark pricing curves. Because there are gaps in the maturities of securities used to construct a c꧙urve, yields must be interpolated between the observable yields.

For example, one of the most 澳洲幸运5开奖号码历史查询:commonly used benchmark curves is the on-the-run U.S. Treasury curve, which is constructed using the most recently issued U.S. Treasury bonds, notes, and bills. Because securities are only issued by the U.S. Treasury with three-month, six-month, two-year, three-year, five-year, 10-year and 30-year maturities, the yields of theoretical bonds with maturities that lay between those maturities must be interpolated. This Treasury curve is known as the 澳洲幸运5开奖号码历史查询:interpolated yield curve (or I-curve) by bond market participants.

Other Popular Bond Benchmark Pricing Curves

• 澳洲幸运5开奖号码历史查询:Spot Rate Treasury Curve: a curve constructed using the theoretical spot rates of U.S. Treasuries
• Swap Curve: a curve constructed using the 澳洲幸运5开奖号码历史查询:fixed interest rate side of 澳洲幸运5开奖号码历史查询:interest rate swaps
• Eurodollars Curve: a curve constructed using interest rates derived from 澳洲幸运5开奖号码历史查询:eurodollar futures pricing.
• Agency Curve: a curve constructed using the yields of non-callable, fixed-rate agency debt

Yield Spreads for Bonds

A bond's yield relative to the yield of its benchmark is called a spread. The spread is used both as a pricing mechanism and as a relative value comparison between bonds. For example, a trader might say that a certain corporate bond is trading at a spread of 75 澳洲幸运5开奖号码历史查询:basis points above the 10-year Treasury. This means that the yield to maturity of that bond is 0.7🦩5% gre🐲ater than the yield to maturity of the on-the-run 10-year Treasury.

Notably, if a different corporate bond with the same 澳洲幸运5开奖号码历史查询:credit rating, outlook and duration were trading at a spread of 90 basis points on a relative value basis, the second bond woඣuld be a better buy.

There are different types of spread calculations used for the different pricing benchmarks. The four primary 澳洲幸运5开奖号码历史查询:yield spread calculations are:

1. 澳洲幸运5开奖号码历史查询:Nominal Yield Spread: the difference in the yield to maturity of a bond and the yield to maturity of its benchmark
2. Zero-Volatility Spread (Z-spread): the constant spread that, when added to the yield at each point on the spot rate Treasury curve (where a bond's cash flow is received), will make the price of a security equal to the 澳洲幸运5开奖号码历史查询:present value of its cash flows
3. 澳洲幸运5开奖号码历史查询:Option-Adjusted Spread (OAS): An OAS is used to evaluate bonds with 澳洲幸运5开奖号码历史查询:embedded options (such as a callable bond or put-able bond). It is the constant spread that, when added to the yield at each point on a spot rate curve (usually the U.S. Treasury spot rate curve) where a bond's cash flow is received, will make the price of the bond equal to the present value of its cash flows. However, to calculate the OAS, the spot rate curve is given multiple interest rate paths. In other words, many different spot rate curves are calculated and the different interest rate paths are averaged. An OAS accounts for interest rate volatility and the probability of the 澳洲幸运5开奖号码历史查询:prepayment of the principal of the bond.
4. 澳洲幸运5开奖号码历史查询:Discount Margin (DM): Bonds with 澳洲幸运5开奖号码历史查询:variable interest rates are usually priced close to their 澳洲幸运5开奖号码历史查询:par value. This is because the interest rate (coupon) on a variable rate bond adjusts to current interest rates based on changes in the bond's 澳洲幸运5开奖号码历史查询:reference rate. The DM is the spread that, when added to the bond's current reference rate, will equate the bond's cash flows to its current price.

Types of Bonds and Their Benchmark Spread Cal✃culation

High-Yield Bonds

High-yield bonds are usually priced at a 澳洲幸运5开奖号码历史查询:nominal yield spread to a specific on-the-run U.S. Treasury bond. However, sometimes when the credit rating and outlook of a high-yield bond deteriorates, the bond will start to trade at an actual 澳洲幸运5开奖号码历史查询:dollar price. For example, such a bond trades at $75.875, as opposed to 500﷽ basis points over the 10-year Treasury.

Corporate Bonds

A corporate bond is usually priced at a nominℱal yield spread to a specific on-the-run U.S. Trea♉sury bond that matches its maturity. For example, 10-year corporate bonds are priced to the 10-year Treasury.

Mortgage-Backed Securities (MBS)

There are many different types of MBS. Many of them trade at a nominal yield spread at their weighted average life to the U.S. Treasury I-curve. Some 澳洲幸运5开奖号码历史查询:adjustable-rate MBS trade at a DM, others trade at a Z-spread. Some CMOs trade at a nominal yield spread to a specific Treasury. For example, a 10-year 澳洲幸运5开奖号码历史查询:planned amortization class bond might trade at a nominal yield spread to the on-the-run 10-year Treasury, or a Z-bond might trade at a nominal yield spread to the on-the-run 30-year Treasury. Because MBS have embedded 澳洲幸运5开奖号码历史查询:call options (borrowers have the free option of prepaying their mortgages🔯), they are frequently evaluated using an OAS.

Asset-Backed Securities (ABS)

ABS frequently trade at a nominal yield spread at their weighted average life to the 澳洲幸运5开奖号码历史查询:swap curve.

Agencies

Agencies frequently trad𒁃e at a nominal yield spread to a specific Treasury, such as the on-the-run 10-year Treasury. Callable agencies are sometimes evaluated based on an OAS where the spot rate curve(s) are derived from the yields on non-callable agencies.

Municipal Bonds

Because of the tax advantages of municipal bonds (usually not taxable), their yields are not as highly correlated with U.S. Treasury yields as other bonds. Therefore, munis frequently trade on an outright yield to maturity or even a dollar price. However, a muni's yield as a ratio to a benchmark 澳洲幸运5开奖号码历史查询:Treasury yield is sometimes used as a relative value measure.

Collateralized Debt Obligation (CDOs)

Like the MBS and ABS that frequently back CDOs, there are many different pricing benchmarks and yield measures used to price CDOs. The eurodollar curve is sometimes used as a benchmark. Discount margins are used on floating rate tranches. OAS calc♛ulations are made for relative 🏅value analysis.

The Bottom Line

Bond market pricing conventions are a little bit tricky, but like baseball rules, 澳洲幸运5开奖号码历史查询:understanding the basics removes some of the ambiguity and may even make it enjoyable. Bond pricing is really just a matter of identifying a pricing benchmark, determining a spread and understanding the difference between two basic yield calculations: yield to maturity and spot rates. With that knowledge, understanding how va🌺rious types of bonds are priced shouldn't be intimidating.