What you will learn
So far in the Sahmino Academy series we have mostly talked about shares, an asset whose return is unknown and swings up and down. But a large part of the capital market is devoted to an instrument where you know in advance exactly how much you will be paid at maturity: fixed-income securities. In this lesson you will learn what these securities are, and what their best-known Iranian example, Akhza (Islamic Treasury Bills), is and how it works; why a seemingly odd rule holds, that "when the market rate rises, the price of existing bonds falls"; and finally how to read the single most important number in this market, the yield to maturity (YTM).
Definitions
A bond (in Persian, owraaq-e qarzeh or owraaq-e bedehi) is, at its simplest, a tradable loan: you hand over money, and the issuer (a government or a company) commits to return the principal on a fixed date and to pay some return in between.
- Face value (arzesh-e esmi): the amount printed on the note, paid to the holder at maturity.
- Coupon (kopon): the fixed periodic interest that some bonds pay before maturity (for example every three months).
- Maturity (sar-resid): the date the note ends and the face value is paid.
- Zero-coupon bond (owraaq-e bedun-e kopon): a bond that pays no periodic interest at all; instead you buy it below its face value, and your entire return comes from the gap between the purchase price and the face value paid at maturity.
Akhza is short for "Islamic Treasury Bills": zero-coupon notes issued by the government. So Akhza is precisely the zero-coupon type of bond, and that single feature makes the rate-versus-price relationship easy to grasp.
How Akhza works, step by step
The story begins with government debt. The state owes money to its contractors and creditors, and instead of paying cash, it gives them a note that, say, one year from now can be cashed for its face value. That is Akhza; its first series was issued in Mehr 1394 (October 2015) with a face value of 1,000,000 rials (100,000 tomans) per note.
The contractor, who wants the money now, sells the note on Farabourse (Iran's over-the-counter exchange) to an investor willing to wait until maturity. Naturally the contractor sells it a little below the face value; that discount is what earns the final buyer a return. At maturity, the government pays the full face value to whoever holds the note.
The inverse relationship between rate and price
Now we reach the heart of the lesson. Because the amount paid at maturity is fixed (the face value), the only variable that determines the buyer's return is the price paid today. The cheaper you buy, the larger your gap to the face value and the higher your yield; the more expensive you buy, the lower your yield.
In other words: a bond's price and its yield move in opposite directions. If the economy's general interest rate rises and investors demand a higher return, they will only buy existing bonds at a lower price so their yield is restored; so the price of those bonds falls. Conversely, when rates fall, that same note with its fixed return becomes more attractive and its price rises. This rule is not specific to Iran; it holds in every bond market in the world.
A worked example (hypothetical)
Suppose a note with a face value of 1,000,000 rials has exactly one year left to maturity.
- If you buy it today for 800,000 rials, at maturity you receive 1,000,000 rials; your gain is 200,000 rials, that is 200,000 divided by 800,000, a yield of about 25 percent.
- Now suppose that tomorrow market rates rise and buyers want a higher return. If the price of that same note falls to 750,000 rials, the new buyer's gain becomes 250,000 rials, a yield of about 33 percent.
Notice what happened: the price fell, the yield rose; the same inverse relationship. Whoever bought the note at the higher price would lose money if they had to sell now; but if they wait until maturity, they still receive that same 1,000,000 rials.
Yield to maturity (YTM)
Yield to maturity, or YTM, answers a precise question: "If I buy this note today at the market price and hold it to maturity, what is my annualized return?" In the example above, because maturity was exactly one year away, the period return and the annualized return were the same; but for a note with, say, six months to maturity, its YTM expresses that six-month gain as an annual rate so you can compare different series against each other.
YTM is the most important yardstick for comparing fixed-income securities, because it condenses price, face value, and time remaining into a single number. You do not need to compute it by hand: trading platforms and the Farabourse site display the YTM of each Akhza symbol in real time.
In Iran's market
A few concrete points about Iran's market that make this lesson practical:
- The issuer is the government. Akhza is the government's debt to you; that is why it is considered the market's lowest-risk security, since the chance of the state defaulting on a rial payment is very low.
- It trades on Farabourse and is highly liquid, meaning you can usually sell whenever you want, though at that day's market price.
- For selling Akhza on the Farabourse side, there is a daily volume limit per individual (100,000 notes), whereas there is no such cap on buying.
- If you do not want to track individual symbols, the simplest route to fixed income is a fixed-income investment fund, which manages a basket of these bonds for you; we cover that instrument separately in the investment funds lesson.
Common mistakes
- "Fixed income means risk-free and loss-free." The hold-to-maturity return is known, but the note's price fluctuates before maturity; if you sell midway you may take a loss. More importantly, its nominal return must be measured against inflation: if inflation exceeds the bond's yield, your purchasing power actually shrinks.
- Confusing the coupon rate with YTM. The coupon rate is fixed and printed on the note, but YTM changes with the day's market price; the two are not the same thing. (Akhza has no coupon at all, so its only yardstick is YTM.)
- Expecting monthly income from Akhza. Akhza is zero-coupon and makes no periodic payment; the entire return arrives at once, at maturity, from the gap between the purchase price and the face value.
Summary
Fixed-income securities are tradable loans, and Akhza is the government's zero-coupon version: you buy below face value and receive the full amount at maturity. Because the maturity amount is fixed, the lower the purchase price the higher the yield; that is why price and yield move in opposite directions, and YTM condenses these three factors into one comparable number. Remember one thing: in bonds, a "higher rate" is good news for the new buyer and bad news for the current holder.
In the previous lesson we covered the initial public offering (IPO); to review the overall map of assets you can also see the what is an asset lesson. The full series is available at the Sahmino Academy learning center.
Analysis
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