FINAL NOTE

BOND MARKETs
 Key concept:
1. Bonds are debt instruments: Bonds are financial instruments that represent a loan made by an
investor to a borrower, typically a government or a corporation. They are used to raise capital
and finance various activities.
2. Issuers and investors: Bonds are issued by various entities, including governments,
municipalities, corporations, and international organizations. Investors purchase bonds as an
investment, seeking fixed income and potential capital appreciation.
3. Coupon payments: Bonds typically pay periodic interest payments, known as coupon payments,
to bondholders. The coupon rate is the fixed interest rate agreed upon at the time of issuance.
4. Maturity and face value: Bonds have a specified maturity date, at which point the principal
amount, known as the face value or par value, is repaid to the bondholder. Maturities can range
from short-term (less than a year) to long-term (over 30 years).
5. Secondary market trading: Bonds can be bought and sold on the secondary market before their
maturity. Bond prices in the secondary market are influenced by various factors, including
interest rates, credit ratings, and market demand.  Usually in DISCOUNTED PRICE
6. Yield and risk: The yield on a bond represents the return an investor receives based on the
bond's price and coupon payments. Bonds with higher credit ratings and lower default risk tend
to have lower yields, while riskier bonds offer higher yields to compensate for the increased risk.
7. Diversification and risk management: Bonds play a crucial role in diversifying an investment
portfolio. They are often considered less risky than stocks and can provide stability and income,
especially during volatile market conditions.
 GOVERNMENT BONDs:

2 loại Bonds chính: T-Bonds (treasury) vs Municipal Bonds

T-Bonds Municipal Bonds

Issuer The federal government State and local governments,
Tax Treatment Subject to federal income tax, but it is Exempt from federal income tax and may
exempt from state and local taxes also be exempt from state and local taxes
Credit Risk Lower Greater
Purpose of Finance federal government activities Fund public projects and infrastructure at
Issuance and fund budgetary needs the state and local government level
Yields Lower Higher

 CORPORATE BONDs:

Bearer bonds Trái phiếu mà trên đó gắn kèm các phiếu lãi
Registered bonds Trái phiếu được đăng ký, thông tin xác định của chủ sở hữu
Term bonds Toàn bộ số lượng trái phiếu đáo hạn vào một ngày duy nhất
Serial bonds Trái phiếu đáo hạn vào một loạt các ngày
Mortgage bonds Trái phiếu dành cho BĐS
Equipment trust Trái phiếu được bảo đảm bằng tài sản vật chất
certificates
 Debentures Trái phiếu chỉ được bảo đảm bởi tín dụng của công ty phát hành
Subordinated Trái phiếu không có tài sản đảm bảo
debentures
Convertible bonds Trái phiếu có thể đổi thành chứng khoán khác của công ty phát hành
Stock warrants Trái phiếu cho phép chủ sở hữu trái phiếu mua cổ phiếu thường của công ty
với giá cố định đến một ngày cụ thể.
Callable bonds Trái phiếu cho phép người phát hành buộc chủ sở hữu trái phiếu bán lại trái
phiếu với giá trên giá trị gốc
Sinking fund provisions Quỹ dự phòng cho trái phiếu để đảm bảo khả năng chi trả trong tương lai

 Question:
1. Compare Government Bonds and Corporation Bonds:

Government Bonds Corporation Bonds

Issuer Government entities Companies
Credit Risk Minimal credit risk + safest form High credit risk + depends on its
of bonds financial stability
Interest Rate Lower Higher
Liquidity Higher Lower

2. Value of Covertible Bonds:

1. Conversion Ratio: The conversion ratio determines the number of shares that the bondholder can convert
the bond into. A higher conversion ratio increases the potential value of the convertible bond.
2. Market Price of the Underlying Stock: The convertible bond derives its value from the underlying stock it
can be converted into. If the market price of the stock increases, the value of the convertible bond will
generally increase as well.
3. Volatility of the Underlying Stock: Higher volatility in the stock price increases the potential value of the
convertible bond, as it provides greater opportunities for the stock price to rise above the conversion
price.
4. Creditworthiness of the Issuer: The creditworthiness of the issuer also influences the value of the
convertible bond. If the issuer's creditworthiness deteriorates, the value of the bond may decrease.

 Question in book:

What are capital markets, and how do bond markets fit into the definition of capital markets?

Capital markets encompass a wide range of financial markets where funds are raised through the
issuance and trading of financial instruments. Maturity >= 1 year → Long-term Financial instruments
Bond markets, also known as the fixed income market, are an integral part of capital markets.
Bond markets specifically deal with the issuance, trading, and valuation of bonds.
Bonds are debt securities that allow entities like governments and corporations to raise capital by
borrowing funds from investors.
Bonds represent loans made by investors to the issuers, with the promise of periodic interest payments
and the return of the principal amount at maturity.
Bond markets play a significant role in capital markets by providing a platform for raising long-term debt
capital.
 Bond markets enable issuers to access funding for various purposes, such as financing infrastructure
projects or supporting business expansion.
Bond markets offer investment opportunities for individuals and institutions seeking fixed income
securities.

What are the differences among T-bills, T-notes, and T-bonds?

Maturity Period:
T-bills: T-bills, or Treasury bills, have the shortest maturity period among the three. They are issued with
a maturity of one year or less, typically ranging from a few days to 52 weeks.
T-notes: T-notes, or Treasury notes, have a medium-term maturity period. They are issued with
maturities ranging from 2 to 10 years.
T-bonds: T-bonds, or Treasury bonds, have the longest maturity period. They are issued with maturities
typically exceeding 10 years, ranging from 20 to 30 years.
Coupon Payments:
T-bills: T-bills do not pay regular coupon or interest payments. Instead, they are issued at a discount to
their face value and redeemed at full face value upon maturity, with the difference representing the
interest earned.
T-notes: T-notes pay semi-annual coupon payments to investors based on a fixed interest rate.
T-bonds: Similar to T-notes, T-bonds also pay semi-annual coupon payments based on a fixed interest
rate.

What is a STRIPS? Who would invest in a STRIPS?

A STRIPS (Separate Trading of Registered Interest and Principal of Securities):

Type of fixed income security created by "stripping" interest payments and principal from a Treasury bond.
STRIPS may be less liquid compared to regular Treasury bonds.
Investors in STRIPS:
 Seek specific cash flows and isolate interest payments or principal component.
 Include financial institutions and individual investors.

Describe the major bond market participants.

The bond market participants include various entities that play significant roles in the buying, selling,
issuance, and trading of bonds. Here are the major participants in the bond market:
Governments and Government Agencies:
o Central governments issue bonds to finance their budget deficits or fund infrastructure projects.
o Government agencies at the federal, state, or local levels may issue bonds for specific purposes,
such as funding education or transportation projects.
Corporations:
o Companies issue bonds to raise capital for business expansion, acquisitions, or debt refinancing.
o Corporate bonds are issued by public and private corporations across various industries.
Financial Institutions:
o Banks, including commercial banks and investment banks, are active participants in the bond
market. (intermediation)
o They may issue bonds as a means of raising funds or engage in bond trading and underwriting
activities.
Institutional Investors:
 o Pension funds, insurance companies, mutual funds, and hedge funds are prominent institutional
investors in the bond market.
o These entities invest large amounts of capital in bonds on behalf of their clients or policyholders
to generate income and manage risk.
Individual Investors:
o Individual investors, including retail investors and high-net-worth individuals, participate in the
bond market.
o They may purchase bonds directly or through mutual funds, exchange-traded funds (ETFs), or
bond brokers.

All else equal, which bond’s price is more affected by a change in interest rates, a short-term bond or a
longer-term bond? Why?

All else being equal, a longer-term bond is more affected by a change in interest rates compared to a
short-term bond. The main reason for this is the difference in the bond's duration. Duration is a measure
of a bond's sensitivity to changes in interest rates. It takes into account the bond's maturity, coupon rate,
and yield. A longer-term bond typically has a higher duration than a short-term bond.
When interest rates rise, the prices of existing bonds tend to decrease. This is because the fixed coupon
payments of the existing bond become less attractive compared to newly issued bonds with higher
coupon rates in the increased interest rate environment.

Discuss the issues surrounding credit rating firms during the financial crisis.

Inaccurate Ratings: Credit rating agencies were criticized for assigning overly optimistic ratings to complex
financial products, such as mortgage-backed securities (MBS) and collateralized debt obligations (CDOs).
These ratings failed to accurately reflect the underlying risks associated with these securities.
Conflict of Interest: Credit rating agencies faced accusations of conflicts of interest. They were paid by the
issuers of the securities they rated, creating a potential incentive to provide favorable ratings to maintain
business relationships and attract more issuers. This conflict of interest compromised the independence
and objectivity of the rating process.
Lack of Transparency: The rating agencies' methodologies and criteria for assigning ratings were not
always transparent. Investors and market participants had limited visibility into the factors and models
used by credit rating agencies, making it difficult to fully assess the accuracy and reliability of their ratings.

What is a convertible bond? Is a convertible bond more or less attractive to a bond holder than a
nonconvertible bond?

A convertible bond is a type of bond that can be converted into a predetermined number of shares of the
issuer's common stock at the bondholder's option. In other words, it gives the bondholder the right to
convert their bond investment into equity ownership in the issuing company.
Advantages of Convertible Bonds:
o Equity Participation: Convertible bondholders have the opportunity to participate in the potential
appreciation of the issuer's stock if the stock price rises significantly. This equity upside can
enhance the total return potential of the bond.
o Downside Protection: Even if the stock price declines, convertible bondholders still have the fixed
income component of the bond, which provides a measure of downside protection. The bond's
coupon payments and principal repayment at maturity offer a cushion against potential losses.
 o Diversification: Convertible bonds offer diversification benefits by combining elements of both
fixed income and equity investments. This can be attractive to investors seeking a balanced
portfolio with exposure to both asset classes.
Disadvantages of Convertible Bonds:
o Lower Coupon Rates: Convertible bonds often offer lower coupon rates compared to
nonconvertible bonds of similar credit quality and maturity. This is because the potential equity
participation feature is considered valuable and leads to a trade-off in terms of lower coupon
payments.

What is a callable bond? Is a call provision more or less attractive to a bond holder than a noncallable
bond?

A callable bond is a type of bond that includes a call provision, which gives the issuer the right to redeem
the bond before its maturity date. The issuer has the option to call back the bond and repay the
bondholder the principal amount along with any accrued interest.
Advantages of Callable Bonds:
o Higher Coupon Rates: Callable bonds typically offer higher coupon rates compared to noncallable
bonds. This higher yield is provided to compensate investors for the risk of early redemption. For
income-oriented investors, the higher coupon payments can be attractive as they provide greater
cash flow.
o Flexibility for the Issuer: Callable bonds provide flexibility for the issuer to manage its debt
obligations. If interest rates decline after the bond is issued, the issuer can take advantage of
lower rates by calling the bond and refinancing at a lower interest rate. This can help reduce the
issuer's borrowing costs.
Disadvantages of Callable Bonds:
 Reinvestment Risk: When a callable bond is called, bondholders may face the challenge of
reinvesting the principal at prevailing lower interest rates. This can result in a lower yield on
reinvested funds, particularly if interest rates have declined since the bond's issuance.
STOCK MARKETs:
Key concepts:
Stock market securities refer to the various financial instruments that are traded on stock exchanges. These
securities represent ownership in publicly traded companies and provide investors with opportunities to participate
in the growth and profits of those companies.

1. Common Stocks: Common stocks represent ownership in a company and typically provide voting rights
and the potential for dividends. Investors in common stocks have the opportunity to benefit from the
company's success.

2. Preferred Stocks: Preferred stocks have characteristics of both stocks and bonds. They offer a fixed
dividend payment and have a higher claim on company assets compared to common stocks. Preferred
stockholders generally do not have voting rights.

3. Exchange-Traded Funds (ETFs):They represent a basket of securities, such as stocks, bonds, or

commodities, and provide investors with diversification and exposure to a specific market or sector.

Question in book:

1. What is meant by the statement “common stockholders have a residual claim on the issuing
firm’s assets”?
The statement "common stockholders have a residual claim on the issuing firm's assets" refers to the position of
common stockholders in the company's capital structure. As residual claimants, common stockholders have the
lowest priority when it comes to claiming the company's assets in the event of liquidation or bankruptcy.

Here's what it means in more detail:

1. Priority of Claims: When a company faces financial distress or liquidation, various stakeholders have claims
on the company's assets. Creditors, such as bondholders and lenders, have priority claims and are typically
repaid first from the company's assets. Common stockholders, on the other hand, have a residual claim,
which means they are entitled to the remaining assets after all other obligations and claims have been
satisfied.

2. Residual Nature: Common stockholders have the right to receive dividends and participate in the
company's profits, but their entitlement is contingent upon the company's financial performance and the
decision of the board of directors. If the company generates profits and declares dividends, common
stockholders may receive a portion of those profits. However, if there are insufficient profits or the
company chooses not to pay dividends, common stockholders have no right to claim those profits.

3. Limited Liability: Common stockholders are not personally liable for the company's debts or obligations
beyond their investment in the stock. In the event of bankruptcy or liquidation, common stockholders can
only lose the value of their investment in the company's stock. They are not responsible for repaying the
company's debts with personal assets.
 2. What is a dual-class firm? Why do firms typically issue dual classes of common stock?

A dual-class firm refers to a company that has issued two classes of common stock, typically designated as Class A
and Class B shares. These different classes of shares carry different voting rights and may have distinct dividend
rights or other preferences.

Firms may choose to issue dual classes of common stock for various reasons, including:

1. Control Retention: One of the primary motivations for dual-class structures is to allow founders,
executives, or a specific group of shareholders to retain control over the company. By holding a class of
shares with superior voting rights (typically Class B shares), insiders can maintain a majority of the voting
power even if their ownership stake decreases over time. This provides them with greater decision-making
authority and protection against potential takeover attempts.

2. Long-Term Vision: Dual-class structures are often implemented by companies that have a long-term vision
and want to protect their strategic direction from short-term pressures. By giving insiders more voting
power, they can focus on long-term growth and resist potential shareholder activism or pressure to
maximize short-term profits.

3. What is the difference between nonparticipating and participating preferred stock?

Nonparticipating preferred stock provides a fixed dividend to stockholders, but they do not share in any additional
dividends beyond their preference. Participating preferred stock, however, allows stockholders to receive both their
fixed dividend and participate in the distribution of additional dividends with common stockholders. The key
difference lies in the participation in excess dividends beyond the preferred amount.

4. What is the difference between cumulative and noncumulative preferred stock?

Cumulative preferred stock allows missed dividend payments to accumulate and be paid in the future, while
noncumulative preferred stock does not accumulate unpaid dividends. Cumulative preferred stockholders have the
right to receive missed dividends before other stockholders, whereas noncumulative preferred stockholders only
have a claim to the current period's dividend.

5. What is a market order? What is a limit order? How are each executed?
Market Order:

 A market order is an instruction to buy or sell a security at the current market price.

 It is executed immediately at the best available price in the market.

 The primary objective of a market order is to ensure a quick execution, prioritizing speed over the specific
price at which the trade is executed.

Limit Order:

 A limit order is an instruction to buy or sell a security at a specified price or better.

  It allows investors to set a specific price at which they are willing to buy or sell the security.

 The order will only be executed if the market price reaches or surpasses the specified limit price.

6. Describe the three forms of stock market efficiency.

1. Weak Form Efficiency:

 In weak form efficiency, stock prices reflect all historical market data, such as past prices and trading
volumes.

 It implies that technical analysis, which uses historical data to predict future prices, cannot consistently
generate excess returns.

 Investors cannot profitably use past market information to gain an advantage in making investment
decisions.

2. Semi-Strong Form Efficiency:

 Semi-strong form efficiency assumes that stock prices reflect all publicly available information, including
not only historical data but also company announcements, financial statements, news reports, and other
relevant information.

 It suggests that fundamental analysis, which involves analyzing financial and non-financial information,
cannot consistently generate excess returns.

 Investors cannot outperform the market by trading based on publicly available information.

3. Strong Form Efficiency:

 Strong form efficiency posits that stock prices reflect all available information, both public and private.

 It implies that even insider information, which is not publicly disclosed, is already incorporated into stock
prices.

 No investor, whether individual or institutional, can consistently generate excess returns by trading on any
type of information.

7. What is the difference between a price-weighted stock market index and a value-weighted
stock market index?
Price-Weighted Stock Market Index:

 In a price-weighted stock market index, the components' weights are determined based on their individual
stock prices.

 The higher the stock price, the greater its influence on the index value.

 Changes in the stock prices of higher-priced stocks have a larger impact on the index compared to lower-
priced stocks.

Value-Weighted Stock Market Index:

 In a value-weighted stock market index, the components' weights are determined based on their total
market capitalization or market value.

 The larger the market capitalization of a stock, the greater its influence on the index value.
 Changes in the market capitalization of larger companies have a greater impact on the index compared to
smaller companies.