BOND FUNDAMENTALS

An Informative Discussion for Investment Management

21 November 2022

Tacandong
1 INVEST101 Talisaysay
Group 8 Tan, Elton
Tan, Joanna
Tan, Kirstel
THE BASICS OF BONDS
DEFINITION, PURPOSE, AND SIGNIFICANCE
BOND FUNDAMENTALS

A bond is a fixed-income instrument that represents an investor's

loan to a borrower (typically corporate or governmental).

A bond can be thought of as an I.O.U. between the lender and the

borrower that includes the loan details and payments.

Companies, municipalities, states, and sovereign governments use

bonds to finance projects and operations.

Bondholders are the issuer's debtholders or creditors.

THE BASICS OF BONDS
DEFINITION, PURPOSE, AND SIGNIFICANCE
BOND FUNDAMENTALS
Purpose
Issued by the government to raise funds.
By purchasing a bond, you are making a loan
to the issuer, who agrees to repay the face
value of the loan on a specific date and to
pay you periodic interest payments along
the way, usually twice a year.
Significance
Can add stability to almost any diversified
portfolio due to its nature of being a safe
and conservative investment.
When stocks perform poorly, they provide a
predictable stream of income, and they are
an excellent savings vehicle when you don't
want to put your money at risk.
BOND CHARACTERISTICS
MATURITY, COUPON RATE, CALLABILITY
BOND FUNDAMENTALS
A bond is simply a loan taken out by a company. Instead of going to
a bank, the company gets the money from investors who buy its
bonds.

In exchange for the capital, the company pays an interest coupon,

which is the annual interest rate paid on a bond expressed as a
percentage of the face value.
BOND CHARACTERISTICS
MATURITY, COUPON RATE, CALLABILITY
BOND FUNDAMENTALS
The company pays the interest at predetermined intervals (usually
annually or semiannually) and returns the principal on the maturity
date, ending the loan.

Unlike stocks, bonds can vary significantly based on the terms of its
indenture, a legal document outlining the characteristics of the
bond.

Because each bond issue is different, it is important to understand

the precise terms before investing. In particular, there are six
important features to look for when considering a bond.
BOND CHARACTERISTICS
MATURITY, COUPON RATE, CALLABILITY
BOND FUNDAMENTALS
Maturity
Defines the lifetime of the bond.
The date when the principal amount of the bond is paid to
the investors, thus ending the company's bond obligation.

Classifications:
Short-term: Bonds that fall into this category tend to
mature within one to three years
Medium-term: Maturity dates for these types of bonds are
normally over ten years
Long-term: These bonds generally mature over longer
periods of time
BOND CHARACTERISTICS
MATURITY, COUPON RATE, CALLABILITY
BOND FUNDAMENTALS
Secured/Unsecured
A bond can be secured or unsecured, and its differences are as
follows:

A secured bond pledges specific assets to bondholders if the

company cannot repay the obligation.
Unsecured bonds: not backed by any collateral.

Liquidation Preference
When a firm goes bankrupt, it repays investors in a particular order
as it liquidates.
BOND CHARACTERISTICS
MATURITY, COUPON RATE, CALLABILITY
BOND FUNDAMENTALS
Coupon
The coupon amount represents interest paid to bondholders,
normally annually or semiannually. The coupon is also called the
coupon rate or nominal yield.

Tax Status
While the majority of corporate bonds are taxable investments,
some government and municipal bonds are tax-exempt, so
income and capital gains are not subject to taxation.

Callability
Some bonds can be paid off by an issuer before maturity. If a bond
has a call provision, it may be paid off at earlier dates, at the option
of the company, usually at a slight premium to par.
RISKS OF BONDS
BOND FUNDAMENTALS
Bond risk is the risk of losing money that is associated
with bond investments. .

Interest Rate Risk

Credit Risk
Inflation Risk
Reinvestment Risk
Liquidity Risk
RISKS OF BONDS
MAIN RISKS OF BOND INVESTMENTS
BOND FUNDAMENTALS

CREDIT RISK
INTEREST RATE RISK This is the risk that an issuer will be
As interest rates fall, bond
unable to make interest or
prices rise. Conversely, when
principal payments when they are
interest rates rise, bond prices
due, and therefore default.
tend to fall.
INFLATION RISK
Inflation reduces the purchasing
power of a bond’s future coupons
and principal.
RISKS OF BONDS
MAIN RISKS OF BOND INVESTMENTS
BOND FUNDAMENTALS

REINVESTMENT RISK
The risk of having to reinvest proceeds
at a lower rate than what the funds
were previously earning. LIQUIDITY RISK
There is a risk an investor might not be able to
sell their corporate bonds quickly due to a thin
market with few buyers and sellers for the bond
and may be forced to sell at a significant
discount to market value.
 Most bonds fall into one of the four general categories:

CORPORATE GOVERNMENT AGENCY

GOVERNMENT

MUNICIPAL
TYPES OF BONDS
AND ITS RISK CONSIDERATIONS
BOND FUNDAMENTALS

RISK CONSIDERATIONS
CORPORATE BONDS Primary risks associated:
Issued by corporations, Credit risk
these bonds may provide Interest rate risk
an investor with a steady Market risk
stream of income
Some corporate bonds may also be called for
redemption by the issuer and have their
principal repaid prior to the maturity date.
TYPES OF BONDS
AND ITS RISK CONSIDERATIONS
BOND FUNDAMENTALS

GOVERNMENT BONDS
A debt security issued by RISK CONSIDERATIONS
a government to support
Primary risks associated:
government spending and
Low credit risk
obligations.
Market risk (if sold
prior to maturity)
Inflation risk
TYPES OF BONDS
AND ITS RISK CONSIDERATIONS
BOND FUNDAMENTALS

GOVERNMENT AGENCY BONDS

These bonds are indirect debt obligations of
RISK CONSIDERATIONS
the U.S. government issued by federal
agencies and government-sponsored entities. Agency and entity bonds
are widely seen as having
low credit risk due to
their association with
government-chartered
entities.
TYPES OF BONDS
AND ITS RISK CONSIDERATIONS
BOND FUNDAMENTALS

MUNICIPAL BONDS
RISK CONSIDERATIONS
refers to a type of debt
It fall somewhere in the middle of the
security issued by local,
county, and state credit risk spectrum.
governments. They are
The risk of default can vary depending
commonly offered to
pay for capital on the creditworthiness of the issuer
expenditures. and the type of debt obligation.
BOND RATINGS
CREDITWORTHINESS OF A BOND
BOND FUNDAMENTALS
A bond rating is a means to assess a bond's creditworthiness,
which relates to how much an issuer will pay to borrow money.

In these ratings, bonds are often given a letter grade

indicating their credit worthiness.

Standard & Poor's, Moody's Investors Service, and Fitch

Ratings Inc. are a few private, independent rating agencies
that assess a bond issuer's financial stability, or its capacity to
make timely principle and interest payments on bonds.
BOND RATINGS
CREDITWORTHINESS OF A BOND
BOND FUNDAMENTALS

Most bonds have ratings issued by at least one of the top independent rating
companies as follows: Standard & Poor's, Moody's Investors Service, and Fitch
Ratings Inc.

Regardless of whether a bond's issuer is a U.S. company or not, these agencies

perform a detailed financial investigation. bonds from overseas companies or
Treasury securities.

Analysts assess an entity's capacity to make payments and maintain liquidity using
the specific criteria established by each agency, while also taking the outlook and
predictions for the future of a bond into account. Based on the accumulation of
these data points, the agencies then announce a bond's overall rating.
BOND RATINGS
CREDITWORTHINESS OF A BOND
BOND FUNDAMENTALS

Bond ratings are assigned by bond ratings agencies with a variety of metrics.

Bonds are assigned letters or letter and number combinations corresponding to their
creditworthiness. These ratings may differ slightly between the bond ratings
agencies based on their unique methodologies.

“Standard & Poor’s and Fitch use an alphabetical grade, with AAA being the highest
rating and D the most likely to default,” says Pine. “From there, a “+/-“ notation can
be added to indicate whether the agency believes a move down or up in credit
quality is likely.” Moody’s utilizes a slightly different alphanumerical hierarchy. In
general, though, once you go past the first B rating an agency offers, the safety of
the bond comes into question.
FACTORS AFFECTING
BOND RATINGS
BOND FUNDAMENTALS

Variables with general Bonds with the highest ratings typically have
correlation to bond ratings: lower yields.

Yield Due to this inverse correlation, businesses must

Chance of ROI offer ever-higher interest rates to entice
Rules controlling the borrowers to lend them money as the possibility
instruments of payback declines.
Corporate assets
The credit quality of a bond may also be affected
by whether it has real assets or insurance backing
in case of default.
INVESTMENT
GRADE-ASSIGNED BONDS
GRADE BONDS
BOND FUNDAMENTALS

Have a rating of BBB-/Baaa3 or higher.

Regarded as investment-worthy by rating agencies.
Manageable level of risk.
Low probability of default.

Investment-grade bonds are the ideal choice for investors wishing to place their
money in a security that is expected to receive both a stable yield and a return of
principal. These bonds may, however, yield lesser yields than trash bonds with higher
levels of risk due to their low risk and stability.
JUNK BONDS
GRADE-ASSIGNED BONDS
BOND FUNDAMENTALS

Have a rating of BB+/Ba1 or lower

Referred to as non-investment grade bonds or high yield bonds.
Higher default risk.

Junk bonds are thought of as speculative investments with a low to high default risk.
To put it another way, even though bonds are typically seen as less hazardous
investments than stocks, these junk bonds could really carry more risks than stocks.

These higher-risk bonds typically have to pay out higher interest rates as a result, in
significant part.
BOND YIELD
RETURN ON BOND INVESTMENTS
BOND FUNDAMENTALS

Bond yields are returns from the bond's interest or coupon payments.
At its core, bonds are loans to bond issuers, explaining why investors
gain interest income from bonds.

Higher yields mean that bondholders are owed larger interest

payments, but may also cover a greater risk. The riskier a borrower is,
the more yield investors demand. These usually occur with a longer
maturity bond.

The simplest way to calculate bond yield is by dividing its coupon

payment by the face value of the bond, also known as the coupon rate.
BOND YIELD
BOND EQUIVALENT YIELD (BEY)
BOND FUNDAMENTALS

The bond equivalent yield is a rate that helps an

investor determine the annual yield of a bond.

This is calculated by dividing the difference between

the face value of the bond and the purchase price of
the bond, by the price of the bond.

The answer will then be multiplied by 365 divided by

"d" which represents the number of days left until the
bond's maturity.
BOND YIELD
EFFECTIVE ANNUAL YIELD (EAY)
BOND FUNDAMENTALS

In cases where semi-annual coupon

payments are made, it is important to
consider the time value of money in the
calculation.

The Effective Annual Yield (EAY) helps

investors define a more precise annual
yield by using the formula as follows:
BOND YIELD
YIELD TO MATURITY (YTM)
BOND FUNDAMENTALS

The yield to maturity refers to the

percentage rate of return for a bond
under the assumption that the investor
holds the asset until its maturity date.

In other words, it is the sum of all its

remaining coupon payments.
BOND YIELD
CURRENT YIELD
BOND FUNDAMENTALS

This formula is most useful for investors who

are only concerned with the current income.

This is calculated by dividing the bond's

annual coupon rate by its current price.

It can also be used to compare the interest

income return on a bond versus dividend
returns from stocks.
BOND YIELD
NOMINAL YIELD
BOND FUNDAMENTALS

It is the percentage of interest on a bond, expressed

as coupon rate, and is paid periodically.

It is calculated by dividing the annual coupon

payment by the face value of the bond.

Do take note that this formula does not estimate

ROIs accurately as it acts only as a measure of
return that solely focuses on interest income.
BOND YIELD
YIELD TO CALL (YTC)
BOND FUNDAMENTALS

Yield to Call (YTC) indicates the gains that an investor

may receive if the bond is called at a particular date.

Some bonds, such as callable bonds, tend to bear

some profitability out of being called before the
maturity date.

It is also possible that investors may receive a higher

yield if the called bonds are paid off at a premium.
BOND YIELD
YIELD TO CALL (YTC)
BOND FUNDAMENTALS

The most recommended way of

calculating a bond's YTC is by using
Excel's YIELD or IRR functions, or
with a financial calculator.

However, you can also compute for

it manually by following the formula
as follows:
BOND YIELD
REALIZED YIELD
BOND FUNDAMENTALS

It is important to calculate
estimated returns one may get
for holding a bond for a certain
period if the investor plans to sell
the bond before its maturity date,.
KEY TAKEAWAYS
TACANDONG, KATRINA BIANCA
Bonds are really just loans from investors to a borrower
[Insert portrait image] intended to raise funds and earn through interest
income and its principal amount.

This topic also taught me that bond yields represent

the returns gained from this fixed-income instrument,
and can be computed in a variety of ways depending
on which formula will be most appropriate for the
terms of the bond.

It also serves as a safe investment that can help

stabilize a diversified portfolio, and can be criticized
through its bond ratings that represent how credible
the bond is.
KEY TAKEAWAYS
TALISAYSAY, GIL ANTON
The bond market broadly describes a marketplace where
[Insert portrait image] investors buy debt securities that are brought to the market by
either governmental entities or corporations. Companies issue
bonds to raise the capital needed to maintain operations, grow
their product lines, or open new locations. Bonds are either issued
on the primary market, which rolls out new debt, or traded on the
secondary market, in which investors may purchase existing debt
via brokers or other third parties. Bonds tend to be less volatile
and more conservative than stock investments, but they also have
lower expected returns.
KEY TAKEAWAYS
TAN, ELTON
I learned that The importance of bond ratings can be seen in the fact
[Insert portrait image] that they are used as a way to determine the financial stability of a
company. The bond rating is an evaluation given by credit rating
agencies that assess the likelihood that the company will be able to
pay off its debts. It also estimates how much risk investors stand if they
lend money to that company.
Bond ratings are important because they make it possible for investors
to make informed decisions about whether or not they want to invest
in certain companies. If a company has a low bond rating, investors
consider it risky and less likely to pay them back on time or at all. This
can be useful information for investors who want to make sure their
investments are safe, but it can also be misleading when someone with
little knowledge about investing relies on these ratings without taking
other factors into account first.
KEY TAKEAWAYS
TAN, JOANNA YVONNE
It is important to establish an attitude to risk before investing.
Investors have to practice risk tolerance because when investing,
we cannot guarantee the exact and satisfying result at the end or
[Insert portrait image]
even in the process of investment before it reaches its own
maturity.

There are a lot of uncertainties that are not controlled by

investors. Results at the end of the process are only done by
nature. Willing to tolerate the ups and downs of the market in the
expectation of higher returns should be somehow considered.

If you’re only willing to accept low or zero levels of uncertainty,

your investment returns are also likely to be low. However, an
investment that seems very attractive in terms of its potential
return may not be the right choice if it carries an unacceptably
high risk.
KEY TAKEAWAYS
TAN, KIRSTEL ISH
I concluded from the presentation that bonds are debt securities
[Insert portrait image] (fixed income investments) and that they are significantly less
risky than equities. Certain investors may consider investing in
bonds because they diversify their portfolios which in result can
provide consistent returns. To invest in this sub-asset class in a
simplified manner, investors can simply choose good debt mutual
funds that invest in bonds. I also learned that Bonds are the most
tangible and readily available source of public finance for
economic development efforts. Coordination among and between
the appropriate bond players throughout the process is critical to
the success of a project when issuing bonds.