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 Investment Bonds Primer
Erik J Abelejabel@gmail.com
 
Who Issues Bonds and Why? ..............................................................................................4 Bond Structure.....................................................................................................................5 Payment Structure................................................................................................................6 Risk......................................................................................................................................7 Credit Risk...........................................................................................................................8 Issuer Type.....................................................................................................................8 Length to Maturity.......................................................................................................10 Credit Rating (Risk Premium).....................................................................................11 Call Provision Risk......................................................................................................11 Interest Rate Risk...............................................................................................................12 Issuing Bonds: The Primary Market..................................................................................13 Coupon Rate.................................................................................................................13 Credit Enhancements...................................................................................................13 Negotiated or Competitive Offering............................................................................14 Pricing Bonds: The Secondary Market..............................................................................14 Bond Yields .......................................................................................................................16 Nominal/Current Yield................................................................................................16 Yield to Maturity..........................................................................................................17 True Yield....................................................................................................................18 
© 2009 Erik J Abel [ejabel@gmail.com]
 
 Investment Bonds Primer
Purpose
This tutorial provides a comprehensive overview of the purpose of investment bonds. Itdescribes where they come from, and how they function as financial instruments, and inthe bond market.The process of structuring bond issues over the years has developed many conventionsand features. There are also many less-common, creative and novel structures andfeatures. This tutorial does not address every possible bond construct. It describes manyof the fundamental and most common structures and features to get you started inunderstanding investment bonds.This tutorial does not:
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Provide investment advice
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Guide you in developing a strategy for how to invest in bonds
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Guide you in choosing in which type of bonds to invest
Acknowledgements
 I wish to express my deep felt appreciation to the people (O.G. and J. P.) who sharedtheir knowledge and time in reviewing this document and providing thoughtful commentsand corrections. I’m grateful for the improvements that their help initiated. I also wish tothank D.S. for her loving encouragement and support and for motivating me to edit.
© 2009 Erik J Abel [ejabel@gmail.com]
 
Investment Bonds Primer
Erik J Abel
To function in an economy - to run a government, to manage a business, to conduct ourlives – on occasion, we need to borrow money. As individuals, we can borrow money –get a loan – from financial institutions, friends or family. Governments and businesseshave the credit-worthiness to borrow money from the financial markets.
 
Issuing bonds is the method by which governments and businesses borrow money fromthe financial markets. A bond is similar to a personal loan. Think about what you wouldwant to know if you were asked to make someone a loan and you will understand thebasic terms of a bond:
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How much do they want to borrow?
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For how long is the money needed and when will you be paid back in full?
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What are you going to get in return for lending the money? When are they goingto give this to you? At regular intervals throughout the term of the loan? At theend of the loan period, when they pay back your money in full?
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How much do you trust that you will get paid back?However, a major difference between your buying a bond and making a personal loan isthat you may seek to purchase a bond because of its value to you as an investment. Assuch, you will shop for a bond that meets your financial objectives in terms of how muchyou expect to earn from it. How much you can expect to earn on a bond is determined bymany factors. Some of these factors include the length to maturity of the bond and thecredit rating of the bond and the bond issuer.But bonds are not only loans. Because a bond holder may want to be paid back in fullbefore the bond matures (before the issuer is obligated to do so), bond holders can and dosell their bonds to others. Thus bonds are also financial instruments that can be traded inthe financial markets, known in the industry as the secondary market.The value of a bond to an investor is as a fixed income investment – an investment thatpays the investor regularly scheduled amounts over time for the use of their money. Thisconcept of a fixed-income, a future cash-flow, informs how bonds are priced in thefinancial markets. In the financial markets the finance theory concept of a discountedcash-flow is used to establish current prices for bonds.Now, we conclude our introduction to bonds with a more formal description of what abond is:
© 2009 Erik J Abel [ejabel@gmail.com] 3
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