Bond Market 6th Ed. (2nd Mid Term)

FinanciaI Markets
and Institutions
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Bond
Markets
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Chapter Objectives Chapter Objectives
Provide inIormational background on U.S.
Treasury, state and municipal, and corporate
Bonds
alculate bond yield Irom quote
Explain the role oI bonds to institutional
investors
Discuss the globalization oI bond markets
ackground on onds ackground on onds
Bonds represent long-term debt securities
ontractual
Promise to pay Iuture cash Ilows to investors
The issuer oI the bond is obligated to pay:
Interest (or coupon) payments periodically usually
semiannually
Par or Iace value (principal) at maturity
Primary vs. secondary market Ior bonds
The issuer`s cost oI Iinancing with bonds
is the coupon rate
Determined by current market rates and risk
Usually Iixed throughout term
Determines periodic interest payments
Bond Interest Rates
The yield to maturity (TYM) is the yield that
equates the Iuture coupon and principal
payments with the bond price
The YTM is the investor`s expected rate oI return iI
the bond is held to maturity
The actual YTM may vary Irom the expected because
oI risks assumed by the investors
Bond Yield to Maturity
An investor can purchase a ten-year, $1000 par
value bond with an 8 percent annualized coupon
rate Ior $936. Determine the yield to maturity Ior
this bond.
N I PV PMT FV
10 936 80 1000
An investor can purchase a ten-year, $1000 par
value bond with an 8 percent annualized coupon
rate Ior $936. Determine the yield to maturity Ior
this bond.
N I PV PMT FV
10 9 936 80 1000
Corporate onds Corporations
Municipal onds State and Local
Governments
Federal Agency onds Federal Agencies
Treasury onds Federal Government
(U.S. Treasury)
Type of ond Issuer
Bonds by Issuers
U. S. Treasury onds U. S. Treasury onds
Issued by the U.S. Treasury to Iinance Iederal
government expenditures
Maturity
Notes, 10 Years
Bonds, ~ 10 to 30 Years
Active OT Secondary Market
Semiannual Interest Payments
Benchmark Debt Security Ior Any Maturity
Treasury onds Treasury onds
Treasury Bond Quotations
8.38 Aug. 2013-18 103:05 103.11 YTM?
oupon rate
Maturity date
Bid/Ask price as percent oI Iace value
Fractions oI price in 32nds
Example: Bid price 103:05, Ask price 103:11
Yield to Maturity (YTM)
U. S. Treasury ond Yield To Maturity U. S. Treasury ond Yield To Maturity
$83.80
Pmt
2013
Today
N
$1000
Ask
Price
FV
$1033.44
PV
*
*
Ask Price 103 and 11/32 oI
Face Value or $1033.4375
alc
YTM
oupon bonds
Interest paid semiannually
To registered bondholders
Stripped Treasury bonds
Zero-coupon securities are sold with claims on U. S.
Treasury bonds held in a trust
One security represents the principal payment (np) at maturity
Other securities represents the interest payments (ci) at interest
paying dates
ash Flow Variation in T-Bonds
Intended Ior investors who seek inIlation
protection with their investments
oupon rates less than other Treasuries
Principal value adjusted Ior the U.S. inIlation rate
(PI) every 6 months
oupon income increases with inIlation
InIlation-Indexed Bonds
Federal Agency onds Federal Agency onds
overnment National Mortgage Association
(NMA)
Issues bonds and uses proceeds to purchase
insured FHA and VA mortgages
A U.S. overnment Agency
Backed by explicit guarantee oI Federal
overnment
Example oI social allocation oI capital
Federal Agency onds Federal Agency onds
Federal Home Loan Mortgage Association
(Freddie Mac)
Issues bonds and uses proceeds to purchase
conventional mortgages
A U.S. government-sponsored agency
No explicit guarantee oI bonds by Iederal
government, but credit risk is very low
Used to provide liquidity Ior thriIts and support oI
home ownership
Municipal onds Municipal onds
State and local government obligations
Revenue bonds vs. general obligation Bonds
Investor interest income exempt Irom Iederal
income tax
Tax ReIorm Act oI 1986 placed limitations on
tax-exempt bond issuance Ior private purposes
Corporate onds Corporate onds
hen corporations want to borrow Ior long-
term periods they issue corporate bonds
Usually pay semiannual interest
Most have maturities between 10-30 years
Public oIIering vs. private placement
Limited exchange, larger OT secondary market
Investors seek saIety oI principal and steady
income
Indenture
Legal document speciIying rights and obligations oI
issuer and bondholder
Trustee
Represents bondholders to assure compliance with
indenture
orporate Bond Terminology
Sinking Fund Provision
Requirement that the Iirm retire a certain amount or
number oI bonds each year
Protects investors with principal reduction
Protective ovenants
Places restrictions on the Iirm to protect bondholders
Examples: limits dividends and oIIicer salaries, restricts
additional debt
all provisions: Ability to pay bonds oII early
all premium
Advantage to issuers; disadvantage to investor
Bond collateral
Usually consists oI a mortgage on real property
Unsecured bonds are called debentures and are backed only
by the general credit oI the issuing Iirm
Low-coupon and zero-coupon bonds
Provide investors known rate oI return
Imputed interest income taxed iI not in tax-sheltered
investment plan
Attractive to pension Iunds with expected payouts
Variable-rate bonds
onvertible bonds
unk Bonds
unk bonds are also called high-yield bonds or
noninvestment rated bonds
Popularized in the direct Iinance boom oI the
1980s
The risk premium is between three and seven
percent above Treasury bonds and susceptible to
contagion eIIects
Secondary market supported by dealer market
Corporate onds Market Quotation Corporate onds Market Quotation
ATT 6 29 7.3 214 88 5/8
th
1/4
AT&T bond quote Ior 1/13/02 (U.S. Exchange Bond)
6.5 coupon rate
Maturity in 2029
7.3 current yield (annual interest/price)
214 bonds traded on this day
Bond priced at close oI day 88 5/8
th
oI Iace
($1000) or $886.25
Bond price up / point Ior the day or $2.50
hibit 7.5 hibit 7.5
Financial nstitution Participation in Bond Markets
Commercial banks and savings Purchase bonds for their asset portfolio.
and loan associations (S&Ls) Sometimes place municipal bonds for municipalities.
Sometimes issue bonds as a source of secondary capital.
Finance companies Commonly issue bonds as a source of long-term funds.
Mutual funds Use funds received from the sale of shares to purchase bonds. Some bond mutual funds
specialize in particular types of bonds, while others invest in all types.
Brokerage rms Facilitate bond trading by matching up buyers and sellers of bonds in the secondary market.
nvestment banking rms Place newly issued bonds for governments and corporations. They may place the bonds
and assume the risk of market price uncertainty or place the bonds on a best-efforts basis
in which they do not guarantee a price for the issuer.
nsurance companies Purchase bonds for their asset portfolio.
Pension funds Purchase bonds for their asset portfolio.

Major Investors in Corporate onds, Major Investors in Corporate onds,
December, 2001 December, 2001
LiIe Insurance ompanies
$1.33 Trillion
Foreign Investors $1.23 Trillion
Households and
Trusts$608 Billion
Mutual
Funds
$420 Bil.
Globalization of ond Markets Globalization of ond Markets
Foreign investment in dollar securities
Foreign issuance by U.S. Iirms
Increased global investment by pension and
mutual Iunds
Development oI Ioreign security markets24
hour trading
Eurobond market
In 1960s, U.S. corporations were limited to the
amount oI Iunds they could borrow in the U.S. Ior
overseas operations.
They began to issue bonds in the Eurobond market
where bonds denominated in various currencies
were placed.
About 75 percent are denominated in U.S. dollars
Eurobond Market
An underwriting syndicate oI investment banks
participates in placing the bonds
Issuer can choose the currency in which the bond
interest and principal are denominated
Dollar denominated most common
Bearer bonds vs. registered bonds
Eurobond Market

Bond Market 6th Ed. (2nd Mid Term)

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Bond Market 6th Ed. (2nd Mid Term)

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FinanciaI Markets

opyright 2002 Thomson Publishing. All rights reserved.

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