Lesson 3 of 5 · 13 min
Seniority, embedded options and yield
Where a bond ranks in repayment and which embedded options it carries shape its risk, and its price and expected cash flows together give its yield, which moves opposite to price.
In short
- Senior debt is repaid before junior (subordinated) debt in bankruptcy or liquidation; junior debt is paid only once senior claims are met.
- Contingency provisions allow an action if an event occurs; for bonds the main ones are embedded call, put and conversion options, which cannot be traded apart from the bond.
- Current yield = annual coupon ÷ price. A lower price means a higher current yield.
- Yield-to-maturity (YTM) is the IRR of the bond's price and cash flows. You earn it only if there is no default, you hold to maturity and you reinvest coupons at the YTM.
- An issuer's yield curve plots YTM against maturity. Its spread over the sovereign curve is compensation for credit risk.
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