Fixed Income Markets and Instruments
Pricing and yield
A bond's price is the present value of coupons and principal, so price and yield move inversely. Yield measures: current yield (coupon divided by price), yield to maturity (all cash flows reinvested at YTM), and yield to call for callables. Accrued interest separates the quoted clean price from the settled dirty price. Money-market instruments often quote discount yields, which understate the true return.
Risk measures
Duration approximates the percentage price change for a small yield move: %ΔP ≈ -D_mod x Δy. Convexity corrects for larger moves and is positive for plain vanilla bonds. Add credit spread, recovery, rating migration, liquidity and reinvestment risk.
Worked example
A bond has modified duration of 6.0 and yields rise 50 basis points. Approximate price change = -6.0 x 0.005 = -3.0%, so a $1,000,000 position loses roughly $30,000. Convexity makes the realised loss slightly smaller than this linear estimate.
Traps
Plugging Macaulay duration directly into the price-change formula (use modified duration); forgetting that a zero-coupon bond's duration equals its maturity; and agreeing settlement amounts on clean price while ignoring accrued interest.