Stories & Ideas

In today's Fixed Income financial investment world, there are many investment avenues for investors which include a plethora of securities and funds. The investment market has broadened by offering different parameters like risk and returns, time frame, liquidity, secured and unsecured, government and private, fixed and floating, etc. One of the investment options getting popular are direct investments in Bonds. Investing in bonds offers a fixed income to investors eliminating the risk and volatility of the securities markets. The investor investing in bonds receives her returns in the form of interest on the invested amount. As is the case with other investments, analyzing the underlying of the investments assumes significance to ascertain whether the instrument / fund is worth deploying funds into. You can look at the following ratios to discover the best fund / security based on your investments objectives. #### **Performance and Return Ratios** ##### Yield to Maturity (YTM) YTM represents the total expected return from holding a bond until maturity, considering both interest payments and the face value. ##### Current Yield It is the annualized interest rate based on the bond's current market price and coupon payments. ##### Duration Duration measures a bond's price sensitivity to changes in interest rates. Higher durations imply higher sensitivity to interest rate changes. ##### Convexity Convexity measures the curvature of a bond's price response to interest rate changes. Higher convexity indicates potential for additional gains or losses. ##### Modified Duration It adjusts duration to account for the bond's call feature, providing a more accurate measure of price sensitivity. ##### Spread The difference in yield between a corporate bond and a comparable government bond, reflecting the credit risk premium. #### **Creditworthiness and Risk Ratios** ##### Credit Rating Provided by credit rating agencies like S&P, Moody's, and Fitch, credit ratings assess an issuer's ability to repay debt. Ratings range from AAA (highest credit quality) to D (default). ##### Default Risk Premium This represents the additional return demanded by investors for holding higher-risk bonds compared to risk-free government bonds. It reflects the compensation for the risk of default. ##### Z-Score A statistical measure of creditworthiness based on financial data, the Z-score assesses the probability of bankruptcy for a company. Higher Z-scores indicate lower bankruptcy risk. ##### Debt-to-Equity Ratio This ratio measures a company's financial leverage by comparing its total liabilities to shareholders' equity. A higher ratio indicates higher financial leverage and potential higher risk. ##### Interest Coverage Ratio It measures a company's ability to service its debt obligations by comparing its operating income to its interest expenses. A higher ratio indicates a lower risk of default. ##### Coverage Ratio This ratio compares a security's cash flow to its interest payments, indicating its ability to cover obligations. Higher coverage ratios signify stronger financial health. #### **Liquidity and Trading Ratios** ##### Bid-Ask Spread The difference between the highest price buyers are willing to pay and the lowest price sellers are willing to accept, representing transaction costs. ##### Trading Volume It measures the daily or average number of bonds traded, indicating market liquidity. ##### Liquidity Ratio This ratio assesses a bond's ease of trading based on market depth and transaction costs. All of these ratios are the factors which influence the pricing of the bonds, also all of these ratios play an important role for any entity for selecting the bond based on their risk appetite and objectives of the investments.