CAPITAL MARKET

MANAGEMENT

MR. ABNER A. AQUINO

abneraquino_ue@yahoo.com
Lecture 1 – Overview of Capital Market
Definition of 'Capital Market'

Capital market is a market where buyers and sellers engage

in trade of financial securities like bonds and stocks. The
buying/selling is undertaken by participants such as
individuals and institutions.

Capital markets help channel surplus funds from savers to

institutions which then invest them into productive use.
Generally, this market trades mostly in long-term securities.
Functions and significance of capital market
1. Link between Savers and Investors:
The capital market functions as a link between
savers and investors. It plays an important role in
mobilizing the savings and diverting them in
productive investment. In this way, capital market
plays a vital role in transferring the financial
resources from surplus and wasteful areas to
deficit and productive areas, thus increasing the
productivity and prosperity of the country.
2. Encouragement to Saving:
With the development of capital market, the
banking and non-banking institutions provide
facilities, which encourage people to save more. In
the less- developed countries, in the absence of a
capital market, there are very little savings and
those who save often invest their savings in
unproductive and wasteful directions, i.e., in real
estate like land, gold, and jewelry and other
conspicuous consumption.
3. Encouragement to Investment:
The capital market facilitates lending to the
businessmen and the government and thus
encourages investment. It provides facilities through
banks and nonbank financial institutions. Various
financial assets, e.g., shares, securities, bonds, etc.,
induce savers to lend to the government or invest in
industry. With the development of financial
institutions, capital becomes more mobile, interest
rate falls and investment increases.
4. Promotes Economic Growth:
The capital market not only reflects the general condition
of the economy, but also smoothens and accelerates the
process of economic growth. Various institutions of the
capital market, like nonbank financial intermediaries,
allocate the resources rationally in accordance with the
development needs of the country. The proper allocation
of resources results in the expansion of trade and
industry in both public and private sectors, thus
promoting balanced economic growth in the country.
5. Stability in Security Prices:
The capital market tends to stabilize the values
of stocks and securities and reduce the
fluctuations in the prices to the minimum. The
process of stabilization is facilitated by
providing capital to the borrowers at a lower
interest rate and reducing the speculative and
unproductive activities.
6. Benefits to Investors:
The credit market helps the investors, i.e.,
those who have funds to invest in long-term
financial assets, in many ways:
(a) It brings together the buyers and sellers of
securities and thus ensure the marketability of
investments,
• (b) By advertising security prices, the Stock
Exchange enables the investors to keep track
of their investments and channelize them into
most profitable lines,
• (c) It safeguards the interests of the investors
by compensating them from the Stock
Exchange Compensating Fund in the event of
fraud and default.
 Primary and Secondary Markets
The buyers, or the investors, buy the stocks or bonds of the
sellers and trade them. If the seller, or issuer, is placing the
securities on the market for the first time, then the market is
known as the primary market. Conversely, if the securities
have already been issued and are now being traded among
buyers, this is done on the secondary market. Sellers make
money off the sale in the primary market, not in the
secondary market, although they do have a stake in the
outcome (pricing) of their securities in the secondary market.
Money Market and Capital Market
Money markets are used for a short-term basis,
usually for assets up to one year. Conversely, 
capital markets are used for long-term assets, which
are any asset with maturity greater than one year. 
Capital markets include the equity (stock) market
and debt (bond) market. Together the money and
capital markets comprise a large portion of the
financial market and are often used together to
manage liquidity and risks for companies,
governments and individuals.
Capital markets are perhaps the most widely followed
markets. Both the stock and bond markets are closely
followed and their daily movements are analyzed as
proxies for the general economic condition of the world
markets. As a result, the institutions operating in capital
markets - stock exchanges, commercial banks and all
types of corporations, including nonbank institutions
such as insurance companies and mortgage banks - are
carefully scrutinized.
The institutions operating in the capital markets access them to 
raise capital for long-term purposes, such as for a merger or acquisition,
to expand a line of business or enter into a new business, or for other 
capital projects. Entities that are raising money for these long-term
purposes come to one or more capital markets. In the bond market,
companies may issue debt in the form of corporate bonds, while both
local and federal governments may issue debt in the form of 
government bonds. Similarly, companies may decide to raise money by
issuing equity on the stock market. Government entities are typically not
publicly held and, therefore, do not usually issue equity. Companies and
government entities that issue equity or debt are considered the sellers in
these markets.
Entities that are raising money for these long-term purposes
come to one or more capital markets. In the bond market,
companies may issue debt in the form of corporate bonds,
while both local and federal governments may issue debt in
the form of government bonds. Similarly, companies may
decide to raise money by issuing equity on the stock market.
Government entities are typically not publicly held and,
therefore, do not usually issue equity. Companies and
government entities that issue equity or debt are considered
the sellers in these markets.
Key Differences Between Money Market and
Capital Market
1. The place where short-term marketable securities are
traded is known as Money Market. Unlike Capital Market,
where long-term securities are created and traded is
known as Capital Market.
2. Capital Market is well organized which Money Market
lacks.
3. The instruments traded in money market carry low risk,
hence, they are safer investments, but capital market
instruments carry high risk.
4. The liquidity is high in the money market, but in the case
of the capital market, liquidity is comparatively less.
5. The major institutions that work in money market are the central bank,
commercial bank, non-financial institutions and acceptance houses. On
the contrary, the major institutions which operate in the money market
are stock exchange, commercial bank, non-banking institutions etc.
6. Money market fulfills short term credit requirements of the companies
such as providing working capital to them. As against this, the capital
market tends to fulfill long term credit requirements of the companies,
like providing fixed capital to purchase land, building or machinery.
7. Capital Market Instruments give higher returns as compared to money
market instruments.
8. Redemption of Money Market instruments is done within a year, but
Capital Market instruments have a life of more than a year as well as
some of them are perpetual in nature.
Capital Market Instruments
 Bond Market
In the bond market, participants can issue new debt
in the market called the primary market or trade
debt securities in the market called the 
secondary market. These products are typically in
the form of bonds, but they may also come in the
form of bills and notes. The goal of the bond market
is to provide long-term financial aid and funding for
public and private projects and expenditures.
 Stock Market

The stock market is the market in which shares of publicly held

companies are issued and traded either through exchanges or 
over-the-counter markets. Also known as the equity market, the
stock market is one of the most vital components of a free-market
economy, as it provides companies with access to capital in
exchange for giving investors a slice of ownership in the company.
The stock market makes it possible to grow small initial sums of
money into large ones, and to become wealthy without taking the
risk of starting a business or making the sacrifices that often
accompany a high-paying career.
Activity:
Cut-out newspaper clippings or search from the
internet business news pertaining transactions
involving stocks and bonds.
Explain the news item on its relevance in
relation to the function and significance of
capital market in business and economy.
Lecture 2 - Investing in Common Stocks
Stocks and Equities
Stocks, sometime called equities, represent
ownership rights in a corporation. When you
invest in a publicly traded company, you get
a stock certificate that indicates how many
shares of the company you own, and serves as
your proof of ownership. Over the short-term,
investing in the stock market can pose quite a
risk.
Stock is a catchall term, used generally to refer
to owning an unspecified number of shares in
a company. Shares is more specific, referring
to how a company's stock is divided. Owning
stock in a corporation means you own a
specific number of shares.Equity is also often
used to describe ownership in a company.
Types of Stocks
Stocks on the basis of ownership rules:
Preferred & common stocks:
The key difference between common and preferred
stocks is in the promised dividend payments. Preferred
stocks promise investors that a fixed amount will be paid
as dividends every year. A common stock does not come
with this promise. For this reason, the price of a
preferred stock is not as volatile as that of a common
stock. Another key difference between a common stock
and a preferred stock is that the latter enjoy greater
priority when the company is distributing surplus money.
However, if the company is getting liquidated
– its assets are being sold off to pay off
investors, then the claims of preferred
shareholders rank below that of the
company’s creditors, and bond- or debenture-
holders. Another distinction is that preferred
shareholders may not have voting rights unlike
holders of common stocks.
Hybrid stocks:
Some companies also issue hybrid stocks.
These are often preferred shares that come
with an option to be converted into a fixed
number of common stocks at a specified time.
These kinds of stocks are called ‘convertible
preferred shares’. Since these are hybrid
stocks, they may or may not have voting rights
like common stocks.
Stocks with embedded-derivative options: 
Some stocks come with an embedded derivative
option. This means it could be ‘callable’ or
‘putable’. A ‘callable’ stock is one which has the
option to be bought back by the company at a
certain price or time. A ‘putable’ share gives the
stockholder the option to sell it to the company
at a prescribed time or price. These kinds of
stocks are not commonly available.
 Stocks according to investment
characteristics
Blue-chip stocks are stocks of large, stable
companies that have a long history of stable
earnings and dividends. Because of their large
size, there is virtually no potential for a high
growth rate, so most of the return of these
stocks is in the form of dividends. However,
capital gains can be earned from these stocks
if they are bought in a bear market, when
stock prices are depressed overall.
Income stocks generate most of their returns
in dividends. These companies have a high
dividend payout ratio because there are few
opportunities to invest the money in the
business that would yield a higher return on
stockholders' equity. Hence, many of the
these companies are already very large, and
are also considered blue-chip companies, such
as General Electric.
Cyclical stocks cycle with the economic cycles,
going up strongly when the economy is
growing and declining as the economy
declines. Most of these companies supply
capital equipment for businesses or big ticket
items, such as cars and houses. The best time
to buy these stocks is at the bottom of a
business cycle, then sell when the cycle peaks.
Defensive stocks are issued by companies that are
resistant to the economic cycles, and may even
profit from them. When consumers and
businesses cut back spending, a few other
businesses profit, either because they offer a way
to cut costs, or because they have the lowest
prices. Wal-Mart was one of the few that actually
thrived, since Wal-Mart is usually recognized as
providing lower prices than other retailers.
Growth stocks are stocks of companies that
reinvest most of their earnings into their
businesses, because it can yield a higher
return on stockholders' equity, and ultimately,
a higher return to stockholders, in the form of
capital gains, than if the money were paid out
as dividends. 
Tech stocks are the stocks of technology
companies, which make computer equipment,
communication devices, and other
technological devices.
Speculative stocks are the stocks of companies
that have little or no earnings, or widely varying
earnings, but hold great potential for appreciation
because they are tapping into a new market, are
operating under new management, or are
developing a potentially very lucrative product that
could cause the stock price to zoom upward if the
company is successful. Many Internet companies
were considered speculative investments.
Category by their market capitalization

While the divisions are indistinct, and will

depend on inflation, a large-cap company is
one with a market cap greater than $5 billion
(P250B and up); a mid-cap company , $1 - $5
billion (P50B-P250B); and small-cap
companies are valued at less than $1 billion
(P50B and below).
Retrieved from: http://thismatter. com/money/stocks/stock-types.htm on
January 22, 2017.
The large-cap stocks consists of the blue-chip,
income, defensive, and cyclical stocks, since
large companies have little potential for
growth. Capital gains can be earned, however,
by buying these stocks at the bottom of a
business cycle and selling them as the
economy reaches full speed. Large-cap stocks
have the best price stability and the least risk.
Mid-cap stocks are composed of most of the
categories listed here, since their market caps
range from the top of the small-cap market to
the bottom of the large-cap market. A particular
kind of mid-cap stock are the baby blue-chip
stocks, which are stocks of companies that, like
the blue-chip companies, have consistent profit
growth and stability, and low levels of debt, but
are smaller in size than the large-cap blue-chips.
Small-cap stocks are small companies that have
the greatest potential for growth — hence,
most of these stocks are growth or speculative
stocks, and most tech stocks are also in this
category, since many tech companies specialize
in a narrow niche of the market, or they were
started to develop a new product or service,
such as the many Internet companies that
sprouted during the stock market bubble.
 Characteristics of Common Stock

1. the right to receive dividend payments typically

from earnings -- if authorized by the board of
directors.
2. the power to sell the stock (liquidity rights) and
realize capital gains on public trading markets or
in private transactions-- if there are willing buyers.
3. the right to receive consideration in a merger or
other fundamental transaction -- if approved by
the board and the shareholders.
4. the right to vote to elect directors and to
approve fundamental transactions (mergers,
sale of assets, amendments to articles,
dissolutions).
5. the right to receive a
proportionate distribution of assets on
corporate liquidation -- if the board and
shareholders approve a dissolution.
Activity:
Conduct a research on the stock profile of a
technology-based company (e.g. Google,
Apple, Amazon, Facebook, Netflix, Xurpas,
etc.)
Identify the company’s stocks in terms of
ownership, investment characteristics, and
capitalization.
The Philippine Stock market
 The Philippine Stock Exchange
The Philippine Stock Exchange (PSE) is the only stock
exchange in the Philippines. It is one of the oldest stock
exchanges in Asia, having been in continuous operation
since the establishment of the Manila Stock Exchange in
1927. It currently maintains two trading floors, one at
the PSE Centre (Tektite), Ortigas Center in Pasig City, and
one at its principal office at the Ayala Tower One in
Makati City’s Central Business District. The PSE is
composed of a 15-man Board of Directors with Jose T.
Pardo as Chairman.
The main index for PSE is the PSEi, which is composed of a
fixed basket of thirty (30) listed companies. The PSEi
measures the relative changes in the free float-adjusted
market capitalization of the 30 largest and most active
common stocks listed at the PSE. The selection of companies
in the PSEi is based on a specific set of public float, liquidity
and market capitalization criteria. There are also six sector-
based indices as well as a broader all shares index.

Trading in the PSE is a continuous session from 9:30AM to

3:30PM daily with a recess from 12:00PM to 1:30PM.
 History
The Philippine Stock Exchange was formed from the
country’s two former stock exchanges, the Manila Stock
Exchange (MSE), established on August 8, 1927, and the
Makati Stock Exchange (MkSE), which was established on
May 27, 1963. 

Although both the MSE and the MkSE traded the same
stocks of the same companies, the bourses were
separate stock exchanges for nearly 30 years until
December 23, 1992, when both exchanges were unified
to become the present-day Philippine Stock Exchange.
In June 1998, the Securities and Exchange
Commission (SEC) granted the PSE a “Self-
Regulatory Organization” (SRO) status, which
meant that the bourse can implement its own
rules and establish penalties on erring trading
participants (TPs) and listed companies.
In 2001, one year after the enactment of the
Securities Regulation Code, the PSE was
transformed from a non-profit, non-stock,
member-governed organization into a
shareholder-based, revenue-earning corporation
headed by a president and a board of directors.
The PSE eventually listed its own shares on the
exchange (traded under the ticker symbol PSE)
by way of introduction on December 15, 2003.
Organizational Structure
 Careers at PSE
The Philippine Stock Exchange, Inc. is a family
whose members share a common goal of
improving the quality of their work lives
through teamwork, confidence, initiative and
competence. All of us at the Exchange are part
of this family, ready to respond to the
challenges of our corporate vision: that of
becoming a premier Exchange with world-
class standards.
We welcome qualified applicants to be part of this
continuously growing family working towards
becoming a premier Exchange - one that we can all
be proud of, for ourselves, and more importantly,
for our country. The following are the current job
openings at the PSE:

Listings Analyst

Software Developer 
 Functions of PSE
Stock exchange is an important element of every
economy. It performs many vital functions for
steady growth and continuous development
of the economy. Some of the
important functions of stock exchange are
explained below. 
(1) Determination of Share Price: The most
important function of stock exchange is the
determination of share prices for everyday trading.
The prices are affected by the forces of demand and
supply. Stock exchange is the place where these
forces meet each other to establish price of a share.
This price then shows the strength of a company in
the market. 
(2) Development of Capital Market: Stock exchange is
the basis of development of capital market. As you
know that capital market has two segment i.e., non-
securities market and securities market. Stock exchange
is a developed form of this securities market. Active
stock exchange helps in better growth of capital market.
It also provides a medium in which different
instruments of capital market can be easily traded. 
(3)  Generation of Savings: Stock market induces
people to save. It teaches them to save and then to
invest savings in right direction. By providing a
profitable way of using savings, stock markets
increase potential of savings in the economy. Higher
savings potentials increases the rate of capital
formation in the country. It also helps in the
expansion of economy in the long run. 
(4) Mobilization of Resources: Stock exchange serves the
vital function of resource mobilization. Not only it attracts
savings from all classes of society but it also channel these
savings in different sectors. So it turn savings into
investment. These investments are then used to extract
and allocate more and more resources of all kind. Efficient
mobilization of resources lead to increase in production
and improvement of living standards. 
(5) Strengthening Industrial Base: Stock exchange strengthen
the industrial base of the country. You are very well aware
that industry needs a huge amount of capital. This need is
mainly fulfilled by stock exchange. It provides an easy
medium by which investment of any amount can be made.
The growth of joint stock companies is also possible because
of stocks exchange. It is also the place where share prices are
quoted and shares and stock are traded. 
(6) Emergence of New Companies: Stock exchange plays
an important role in emergence of new companies and
industries. A company listed on the stock exchange enjoys
a higher confidence of public and general investor. So it is
in a better position to attract investment and to raise
minimum subscription. Thus in the presence of stock
exchange new projects can be started relatively easily.
Stock exchange also helps in raising finance for
establishing new lines of production and industrial units. 
(7) Healthy Corporate Structure: Stock exchange helps in the
maintenance of corporate structure of the economy. It is a
source of promotion for sound and healthy companies. It has
its particular set of rules and regulation which are to be abided
by all the listed companies. These rules ensures fair running of
the affairs of company. Also companies are required to send
their interim and final reports to stock exchange where they
are listed. Thus investor can get these reports from stock
exchange and study affairs of desired company. 
(8) Financial Stability: Stock exchange has a vital
role in financial stability. Trends in stock
exchange effect all major sectors of the economy.
That is why the governing authorities (Security
and Exchange Commission) always keep a close
eye on the conditions of stock exchange. 

Read more: 
http://www.affordablecebu.com/load/finance_w
ealth/functions_of_stock_exchange/34-1-0-2789
#ixzz4YBkHn3Cv
Lesson 3
Investing in Fixed-Income Securities
What is a Bond?
bond is a fixed income investment in which an
investor loans money to an entity (typically
corporate or governmental) which borrows the
funds for a defined period of time at a variable or
fixed interest rate. Bonds are used by companies,
municipalities, states and sovereign governments
to raise money and finance a variety of projects
and activities. Owners of bonds are debt holders,
or creditors, of the issuer.
Bonds are commonly referred to as 
fixed-income securities and are one of the
three main generic asset classes, along with
stocks (equities) and cash equivalents. Many
corporate and government bonds are publicly
traded on exchanges, while others are traded
only over-the-counter (OTC).
How Bonds Work

When companies or other entities need to raise money to

finance new projects, maintain ongoing operations, or
refinance existing debts, they may issue bonds directly to
investors instead of obtaining loans from a bank. The indebted
entity (issuer) issues a bond that contractually states the 
interest rate that will be paid and the time at which the loaned
funds (bond principal) must be returned (maturity date). The
interest rate, called the coupon rate or payment, is the return
that bondholders earn for loaning their funds to the issuer.
Illustration
Because fixed-rate coupon bonds will pay the same percentage
of its face value over time, the market price of the bond will
fluctuate as that coupon becomes desirable or undesirable
given prevailing interest rates at a given moment in time. For
example if a bond is issued when prevailing interest rates are
5% at $1,000 par value with a 5% annual coupon, the
bondholder will be credited $50 in interest income annually.
The bondholder would be indifferent to purchasing the bond
or saving the same money at the prevailing interest rate.
However, if interest rates in the economy drop to 4%, the
bond will continue paying 5% coupon rates, making it a
more attractive option. Investors will purchase these
bonds, bidding the price up to a premium until the
effective rate of the bond equals 4%. On the other hand, if
interest rates rise to 6%, the 5% coupon is no longer
attractive and the bond price will decrease, selling 
at a discount until it's effective rate is 6%.

Because of this mechanism, bond prices move inversely

with interest rates.
Characteristics of Bonds

Face value is the money amount the bond will be worth at its
maturity, and is also the reference amount the bond issuer uses
when calculating interest payments. For example, say an investor
purchases a bond at a premium $1,090 and another purchases
the same bond at a discount $980. When the bond matures, both
investors will receive the $1,000 face value of the bond.
Coupon rate is the rate of interest the bond issuer will pay on the
face value of the bond, expressed as a percentage. For example, a
5% coupon rate means that bondholders will receive 5% x $1000
face value = $50 every year.
Coupon dates are the dates on which the bond issuer
will make interest payments. Typical intervals are
annual or semi-annual coupon payments.
Maturity date is the date on which the bond will
mature and the bond issuer will pay the bond
holder the face value of the bond.
Issue price is the price at which the bond issuer
originally sells the bonds.
Two features of a bond – credit quality and duration
 – are the principal determinants of a bond's
interest rate. If the issuer has a poor credit rating,
the risk of default is greater and these bonds will
tend to trade a discount. In addition, bonds with a
high default risk, such as junk bonds, have higher
interest rates than stable bonds, such as
government bonds.
Credit ratings are calculated and issued by credit
rating agencies. Bond maturities can range from
a day or less to more than 30 years. The longer
the bond maturity, or duration, the greater the
chances of adverse effects. Longer-dated bonds
also tend to have lower liquidity. Because of
these attributes, bonds with a longer time to
maturity typically command a higher interest
rate.
When considering the riskiness of bond
portfolios, investors typically consider the
duration (price sensitivity to changes in interest
rates) and convexity (curvature of duration).
Bond Issuers

Corporate bonds are issued by companies.

Municipal bonds are issued by states and municipalities.
Municipal bonds can offer tax-free coupon income for
residents of those municipalities. 
Treasury bonds (more than 10 years to maturity), notes
 (1-10 years maturity) and bills (less than one year to
maturity) are collectively referred to as simply
"Treasuries."
Varieties of Bonds

Zero-coupon bonds do not pay out regular coupon payments,

and instead are issued at a discount and their market price
eventually converges to face value upon maturity. The
discount a zero-coupon bond sells for will be equivalent to
the yield of a similar coupon bond.
Convertible bonds are debt instruments with an embedded 
call option that allows bondholders to convert their debt
into stock (equity) at some point if the share price rises to a
sufficiently high level to make such a conversion attractive.
Some corporate bonds are callable, meaning that the issuer
can call back the bonds from debtholders if interest rates
drop sufficiently. These bonds typically trade at a premium
to non-callable debt due to the risk of being called away and
also due to their relative scarcity in the bond market. Other
bonds are putable, meaning that creditors can put the bond
back to the issuer if interest rates rise sufficiently.
The majority of corporate bonds in today's market are so-
called bullet bonds, with no embedded options and a face
value that is paid immediately on the maturity date.
Bond Valuation
 Behavior of Market Interest Rate
Once a bond is issued the issuing corporation
must pay to the bondholders the bond's
stated interest for the life of the bond. While
the bond's stated interest rate will not change,
the market interest rate will be constantly
changingdue to global events, perceptions
about inflation, and many other factors which
occur both inside and outside of the
corporation.
Market interest rates are likely to increase when
bond investors believe that inflation will occur.
As a result, bond investors will demand to
earn higher interest rates. The investors fear
that when their bond investment matures,
they will be repaid with dollars of significantly
less purchasing power.
Market interest rates are likely to decrease when
there is a slowdown in economic activity. In
other words, the loss of purchasing power due
to inflation is reduced and therefore the risk of
owning a bond is reduced.
Relationship Between Market Interest Rates and a Bond's Market
Value
When market interest rates increase, the market value of an
existing bond decreases.
When market interest rates decrease, the market value of an
existing bond increases.
The relationship between market interest rates and the market
value of a bond is referred to as an inverse relationship. Perhaps
you have heard or read financial news that stated "Bond prices
and bond yields move in opposite directions" or "Bond prices
rallied, lowering their yield..." or "The rise in interest rates caused
the price of bonds to fall."
If you were the treasurer of a large corporation
and could predict interest rates, you would...
Issue bonds prior to market interest rates
increasing in order to lock-in smaller interest
payments.
If you were an investor and could predict interest rates, you
would...
Purchase bonds prior to market interest rates dropping. You
would do this in order to receive the relatively high
current interest amounts for the life of the bonds.
(However, be aware that bonds are often callable by the
issuer.)
Sell bonds that you own before market interest rates rise.
You would do this because you don't want to be locked-in
to your bond's current interest amounts when higher rates
and amounts will be available soon.
Pricing of Bonds
One of the most basic concepts that investors
should become familiar with is 
how bonds are priced. Bonds do not trade like
stocks. The pricing mechanisms that cause
changes in the bond market are not nearly as
intuitive as seeing a stock or mutual fund rise
in value.
Bonds are loans; when you purchase a bond, you
are making a loan to the issuing company or
government. Each bond has a par value, and it can
either trade at par, at premium, or at discount.
The interest paid on a bond is fixed, but the yield
– the interest payment relative to current bond
price – fluctuates as the bond's price fluctuates.
Put simply, bond prices fluctuate on the 
open market in response to supply and demand
for the bond. The price of a bond is determined by
discounting the expected cash flow to the present
using a discount rate. Three primary influences on
bond pricing on the open market are supply and
demand, age-to-maturity and credit ratings.
Pricing on Premium Bonds and Discount Bonds
Bonds are issued with a set face value and trade at par when
the current price is equal to the face value. Bonds trade 
at a premium when the current price is greater than the
face value. For example, a $1,000 face value bond selling
at $1,200 is trading at a premium. Discount bonds are the
opposite, selling for lower than the listed face value.
Bonds that are priced lower have higher yields, and they are
therefore more attractive. For instance, a $1,000 face
value bond that has a 6% interest rate pays $60 in annual
interest every year regardless of the current trading price.
Interest payments are fixed. When the bond is currently
trading at $800, that $60 interest payment creates a
present yield of 7.5%. Since you would rather pay $800 to
earn $60 than pay $1,000 to earn that same $60, bonds
with higher yields are better buys.
Bond Duration and Pricing
The age of a bond relative to its maturity has a significant
effect on pricing. Bonds are paid in full (at face value)
when they mature, though there are options to call, or
redeem, some bonds before they mature. Since a 
bondholder is closer to receiving the full face value as the 
maturity date approaches, the bond's price moves
toward par as it ages.
Age and demand for bonds influence prices, and the 
ratings provided to bonds and their issuers also have a
large impact. There are three primary rating agencies,
and the ratings that they assign act as signals to investors
about the creditworthiness and safety of the bonds.
Since bondholders are less likely to purchase bonds with
poor ratings (and thus a lower chance of repayment by
the issuer), the price of those bonds is likely to fall.
Pricing on Callable Bonds
Investors considering how the approach of a maturity
date will affect the price of a bond should also be
aware of the effect that a call feature has on the
bond. Callable bonds can be redeemed prior to the
date of maturity at the issuer’s discretion.
Because of the possibility for early redemption, if
interest rates have gone down, the bond's price will
act in a way that reflects an approach to maturity;
this situation makes it more appealing to the issuer
to redeem the bond early. If interest rates have
gone up, an approaching call date will not greatly
affect the bond's price, as the issuer is less likely to
exercise the option to call the bond.
Measures of Yield and Return
Because investors are very concerned with how
well their investments are performing or how
they are expected to perform, knowing how to
gauge such performance is essential. This
makes understanding the difference between 
yield and return important.
While both terms are often used to describe the
performance of an investment, yield and
return are not one and the same thing.
Knowing what each measure takes into
account and recognizing that each considers
different time periods is key.
Return, also referred to as "total return," expresses
what an investor has actually earned on an
investment during a certain time period in the past.
It includes interest, dividends, and capital gain (such
as an increase in the share price). In other words,
return is retrospective, or backward-looking. It
describes what an investment has concretely
earned.
Yield, on the other hand, is prospective, or forward-looking.
Furthermore, it measures the income, such as interest and
dividends, that an investment earns and ignores capital
gains. This income is taken in the context of a certain time
period and then annualized, with the assumption that the
interest or dividends will continue to be received at the
same rate. Yield is often used to measure bond or debt
performance; in most cases, total return will not be the
same as the quoted yield due to fluctuations in price.