THE BOND MARKET

A Deeper Understanding of a Major Economic Market Emma Ricci

WHAT IS A BOND?
A bond is a debt security, similar to an I.O.U.
When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer.
Bonds issued by corporations or the US government are
usually taxable Bonds issued by state governments or municipalities are usually exempt from tax

Components
The issuer, similar to a holder of an option Principal amount Specified interest rate; paid to the issuer
yearly (also known as the coupon) Date of maturity

Variables that Effect Value

Maturity Redemption Features Credit Quality Interest Rate Price Yield Tax Status

MATURITY
1.Short-term notes: maturities of up to 4 years; 2.Medium-term notes/bonds: maturities of five to 12 years; 3.Long-term bonds: maturities of 12 or more years.

REDEMPTION FEATURES
Bond with a redemption provision usually have
higher return to compensate for the risk that the bonds might be called early. CALL Option: provisions that allow or require the issuer to repay the investors principal at a specified date before maturity. PUT Option: option of requiring the issuer to repurchase the bonds, at a specified time, prior to maturity.

CREDIT RATINGS

Each of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond.

Credit Ratings
Credit Risk
Prime Excellent Upper Medium Lower Medium Speculative Very Speculative Default

Standard and Poor's Moody's

Aaa Aa A Baa Ba B, Caa Ca, C AAA AA A BBB BB B, CCC, CC D

Fitch
AAA AA A BBB BB B, CCC, CC, C DDD, DD, D

INTEREST RATES
FIXED:
Stays same until maturity; ie: buy a $1000 bond with 8% fixed interest rate and you will receive $80 every year until maturity and at maturity you will receive the $1000 back.

FLOATING: adjustable to prevailing market rates. PAYABLE AT MATURITY: receive no

payments until maturity and at that time you receive principal plus the total interest earned compounded semiannually at the initial interest rate.

PRICE
The amount you pay for the bond
Newly issued bonds will pay close to their facevalue Traded bonds fluctuate in response to changing interest rates
Bonds traded higher than their face-value are said to
be sold at a premium Bonds traded lower than their face-value are said to be be sold at discount

YIELD
Yield is the return you actually earn on the
bond--based on the price you paid and the interest payment you receive Two Types of Yields: Current Yield: annual return on the dollar amount paid for the bond and is derived by dividing the bond's interest payment by its purchase price Yield To Maturity: total return you will receive by holding the bond until it matures or is called.

YIELD contd
From the time a bond is originally issued until the
day it matures, its price in the marketplace will fluctuate according to changes in market conditions or credit quality. The constant fluctuation in price is true of individual bonds-and true of the entire bond market-with every change in the level of interest rates typically having an immediate, and predictable, effect on the prices of bonds.

YIELD (Linking price and yield)

Most important thing to remember!!!!
**When prevailing interest rates rise, prices of outstanding bonds fall to bring the yield of older bonds into line with higher-interest new issues **When prevailing prices fall, prices of outstanding bonds rise, until the yield of older bonds is low enough to match the lower interest rate on new issues.

YIELD (Linking interest rate and maturity)

The longer it takes for a bond to mature, the
greater the risk that prices will fluctuate along the way By watching a yield curve you can gain a sense of where the market perceives interest rates to be headed

TAXABLE STATUS
Some bonds offer special tax advantages.
There is no state or local income tax on the interest from U.S. Treasury bonds, and no federal income tax on the interest from most municipal bonds, and in many cases no state or local income tax, as well.

INTEREST RATE-INFLATION
As a general rule: the bond market, and the
overall economy, benefit from steady, sustainable growth rates. But steep rises in economic growth can lead to inflation, which raises the costs of goods and services for everyone, leads to higher interest rates and erodes a bond's value.

INTEREST RATE-INFLATION
Interest rates rise due to:
The Federal Reserve trying to slow economic
growth through market forces acting in anticipation of interest rate moves **Since rising interest rates push bond prices down, the bond market tends to react negatively to reports about strong economic growth.

TYPES OF BONDS
Municipal: issued to raise money for schools, hospitals, highways, etc. Corporate: debt obligations issued by private and public corporations Zero-Coupon: Bonds with no periodic interest payments (introduced to the marketplace in 1982)

MARKETABLILITY
How quickly and easily a bond can be
bought or sold For a bond to have high marketability, there must be a large trading volume as well as a large number of dealers in the security

Bond Market Tables

Example of Treasury table would look as
follows: RATE MATURITY BID ASK YLD 7 3/4 Feb. 01 105:12 105:14 5.5 5 3/8 Feb. 01 99:26 99:27 5.44

Bond Market Tables

Example of Tax-exempt
ISSUE COUPON MAT PRICE YLD to MAT GO bonds 5.00 5-15-28 97 1/8 5.19 Public Power 5.00 1-1-28 97 5.2 District

Bond Market Tables

Example of Corporate Exchange Traded
bonds BONDS Cur Yld BosCel 6s38 9.2 PacBel 65/8s34 6.7 Vol. Close Net chg 22 65 3/8 +1/4 5 991/8 -1/8

BOND BENEFITS
Some portion of portfolio should be in
bonds High degree of safety with regular, scheduled,
predictable payments