What is a bond?

Legal contract between a borrower & some investor that will detail present & future
flows of cash

Basic Concept

 How to price a bond:

- Through net present value of future cash flows

- Is the sum of the future cash flow discounted to a rate

Past 14 years:

There is a crack in the bond market (2000-2002) because the inflation, temporary
phenomenon, market liquidity risk and more uncertainty.

There is expectations that in 2023 the uncertainty will calm down and therefore the crack
of the bond market volatility (2000-2003) will be stable.
Chapter 1:

1. BASIC FEATURES OF A BOND

Introduction and definition

- Types of fixed income securities and their characteristics

Key Words:

- Issuer  Borrower
- Maturity  Date of Repayment
- Principal  Borrowed Amount
- Coupon  Rate and Frequency
- Currency  Local, Foreign
- Jurisdiction  Domestic, London, New-York, Switzerland

Type of Issuers:

Maturity:

- Maturity will aim at matching issuer funding needs and investor appetite
 - Rating agencies will consider hybrid bond as 50% equity and 50% bond depending
on conditions
Coupon:

- Reinvestment risk will depend on coupon frequency

- With a Zero Coupon, the investor in term of rate will expect the following:

 If he excepts the rate will decrease in the years, the present value
of the bond will be higher
 If he expects the rate will increase in the years, the present value of
the bond will be lower

o This is because the future cash flow discounted method formula

Reference Rate:
 - Following the recent scandals, Central Banks have set-up new benchmarks to
restore credibility in the lending market

Reference Rate: New Benchmarks

Risks & opportunities for the buyer of a bond:

- All these risks are embedded in the price of a bond (or yield)
 2. LEGAL, REGULATORY AND TAX CONSIDERATIONS:

Tax:

The bond indenture:

The covenants will balance the risk-reward level expected by issuers and investors

Covenants:
Maintenance: Means that the investor is in default

Example:
 3. Bond Cash Flows:

- The issuer will receive 1,000 at origination and will pay an annual coupon of €60
- At maturity it will pay the full principal amount and last coupon (1,000 + 60)

Fully Amortized Bond:

Partially Amortized Bond:

Summary:
Bond types:
 4. BONDS WITH OPTIONS:

Types:

- Call option: refinance the debt into better conditions

- Put Option (investor): allows to protect themselves against rise interests

5. CREDIT RATING:

 Credit agencies are key players in the fixed income market as providing a
prospective and dynamic assessment of bond issuers
 Most investors are dependant of credit agencies for their investment
 The credit rating market is dominated by three agencies : Standard &Poors,
Moody’s and Fitch
 Post financial crisis, rating agencies are better regulated and the market is slowly
opening to competition

Strengths:

 Strengths o Improved regulation dedicated to enforce protection for investors

 Common language for markets participants
 Long track record and extensive database
Challenges:

 Increasing popularity overtime which has removed the role of certifier for banks
and lead to greater moral hazard risk
 Ideal business model has yet to be finalized (paid by issuers)
 Credibility and trust must be preserved
 Lack of competition and concentration of credit risk assessment

Example:
 - Coverage = EBITDA/Interest

Example:
Completar slides hasta aca:
Exam Questions:

1. C
2. A
3. B
Completar Hasta aca
 1 P/YR
As Par Value =- 100
- FV: 100
- PV: - 96
- N: 14
- PMT: 5%/2  2.5%
- Ask for  I%YR: 2.85%

Annual Percentage Rate: 2.85 * 2  5.7%

Other Way:

2 P/YR
As Par Value =- 100
- FV: 100
- PV: - 96
- N: 14
- PMT: 5%/2  2.5%
- Ask for  I%YR: 5.7%

Año 3:
2 P/YR
As Par Value =- 100
- FV: 105
- PV: - 96
- N: 14
- PMT: 5%/2  2.5%
- Ask for  I%YR: 7.27
Año 5:

2 P/YR
As Par Value =- 100
- FV: 105
- PV: - 96
- N: 8 (4*2)
- PMT: 5%/2  2.5%
- Ask for  I%YR: 6.6%
At year 3
1 P/YR
- FV: 100
- PV: - 98
- N: 3
- PMT: 8%
- Ask for  I%YR: 8.79%