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When the Japanese government requires funds, it borrows them from the public by issuing bonds. The Japanese government bond has a fixed initial price, maturity date and maturity value. Investors buy the Japanese government bonds and earn profits in the form of coupon payments or a maturity value that is higher than the price the investors initially paid to buy the bonds. The Japanese government bond is a relatively safe financial instrument because the payments are guaranteed by the Japanese government. Several types of Japanese government bonds are available to both Japanese and non-Japanese investors and intermediaries.
When a Japanese government bond first enters the market, an investor pays a predetermined price to buy it from approved financial institutions. At maturity, the investor gets back the money he paid to purchase the bond. In the case of discount bonds, the investor pays less at purchase than he gains at maturity. In the case of coupon bonds, he or she receives fixed coupon payments every six months during the life of the bond. Another type of coupon bond, known as floating-rate bonds, are linked to a floating interest rate and the amount of each coupon payment varies.
An investor does not have to hold on to a Japanese government bond from initial purchase to maturity. The market trades these bonds, and investors can buy or sell them at any time before maturity. The market price could differ from the initial purchase price, depending on such factors as supply, demand, competition with other types of bonds and the economic situation in Japan.
The return an investor earns on a Japanese government bond is expressed as the yield to maturity. It depends on the price the investor paid to purchase the bond, the coupon rate and the time between purchase and maturity. The formula for yield to maturity is [(nominal coupon rate in percentage) + ((¥100 - purchase price) / maturity in years)] / purchase price. Multiply the result by 100 to get the pre-tax yield to maturity as a percentage.
The Japanese government bond has a wide range of maturity periods. Discount bonds have short maturity periods of between six months and one year. Coupon bonds have maturity periods of between two years and 40 years.
The Japanese government bond also has various initial purchase prices for the different kinds of bonds it issues. The 10-year floating-rate and five-year fixed-rate bonds for retail investors have the lowest purchase price. Short-term discount bonds have the highest purchase price.
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