NSE HAS GIVEN A GOOD AMOUNT OF KNOWLEDGE IN THEIR RESOURCE SECTION.
link mentioned below:-
http://nseindia.com/invest/resources/download/RDM.pdf
still there are certain questions which come to mind :-
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the bonds have a face value of rs.100 & interest is paid every 6 months … why are they traded at a premium or discount on the face value ? factors affecting this “TRADING PRICE” ?
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interest payment mentioned on page 2 of the pdf ,is also a little tricky to understand .
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as per example mentioned on page 5 ,buying 12%GOI 2008 at 122.52 on june-1-2002 & selling at 130.28 on jan-1-2003 … how does this trade earn you 18% annualized return +(in addition to) half yearly interest of 12% ?
i will be highly indebted to anyone ,who will explain this to me in simple understandable way .
thank you
- For example say face value of bond is 100 and trading price is 100 when issued and interest rates are 5% and coupon in 5% paid annually.
Suppose interest rates have gone up to 7% then trading price should be adjusted accordingly, what if not?
Case 1: I will short bond and deposit the proceedings at present interest rate of 7% and earn 2% of free money. Ideally there is no concept of free money so trading price has to reflect current interest rates.
case 2: Why one will be interested in buying a bond which pays 5% interest when the current market provides me with 7%.So in this case also bond has to reflect current scenario of interest rates by trading below face value.
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For example, coupon is paid semiannually one time on january 1st and one time on july 1st. So if one buys bond on june 30th and on june 1st as he is the owner of bond he is entitled to receive coupon payment which logically does not make anysense. So, the buyer has to pay the accrued interest to seller as the seller is holding the bond till june 30th(In this example). So the price paid(dirty price) is a combination of quoting price( clean price) plus accrued interest.
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Return earned is equal to = capital gains + Interest received
So in this case capital gain= (130.22 - 122.52) / 122.52 = 6%
Interest earned for the above bond annually is 12%
Total earning = 6% + 12%= 18% annually.
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mr. siva this answer has been a great help 
followup questions ;-
- 12% interest is earned on face value , not on the price at which i buy since i got 12 rupees for 122.52 … interest earned = 9.79% , please do correct me if i am wrong .
- considering capital gains 6% & interest 9.79% earnings are 15.79 % … but this earning is half year earning ( 1 st june to 1 jan ) . why does the NSE pdf use the term “annualized return” .
12% is on face value which is 100 and not on trading price.
I believe It should answer your two questions.
i am aware interest is paid on face-value . .
i still did not understand how they claim 18% annual return , because my calculation says its 15.79% half yearly return . please explain
