BOND MARKETS

MCGRAW-HILL/IRWIN 6-1

©2009, The McGraw-Hill Companies, All Rights Reserved

PREMYO BONDS

 https://www.youtube.com/watch?v=9zsuaH4Wkc8

MCGRAW-HILL/IRWIN 6-2

©2009, The McGraw-Hill Companies, All Rights Reserved

LEARNING OUTCOMES

Discuss how the capital markets operate

(the money and the bond markets)
Describe the different securities in the
bond’s market

MCGRAW-HILL/IRWIN 6-3

©2009, The McGraw-Hill Companies, All Rights Reserved

 RECALL:
BOND AND BOND MARKETS

Capital
Capital markets
markets involve
involve equity
equity and
and debt
debt
instruments
instruments with
with maturities
maturities of
of more
more than
than one
one year
year

Bonds
Bonds are
are long-term
long-term debt
debt obligations
obligations issued
issued by
by
corporations
corporations and
and government
government units
units

Bond
Bond markets
markets areare markets
markets in
in which
which bonds
bonds are
are
issued
issued and
and traded
traded

 Treasury
Treasurynotes
notes(T-notes)
(T-notes)and
andbonds
bonds(T-bonds)
(T-bonds)

 Municipal
Municipalbonds
bonds(Munis)
(Munis)

 Corporate
Corporatebonds
bonds
MCGRAW-HILL/IRWIN 6-4

©2009, The McGraw-Hill Companies, All Rights Reserved

MCGRAW-HILL/IRWIN 6-5

©2009, The McGraw-Hill Companies, All Rights Reserved

 TYPES OF SECURITIES
ISSUED BY THE NATIONAL GOVERNMENT THROUGH
THE BUREAU OF THE TREASURY (BTR)

• Treasury bills (fixed-rate)

• Treasury bonds (fixed-rate coupon-bearing and zeroes)
• Retail treasury bonds (RTBs, fixed-rate coupon-bearing)
• Multi-currency retail treasury bonds (MRTBs, fixed-rate coupon-
bearing)
• Dollar-linked peso notes (fixed-rate)
Issued by the National Government through Other Entities
• Debt securities issued by government-owned and -controlled
corporations (GOCCs)
• Debt securities issued by government agencies
MCGRAW-HILL/IRWIN 6-6

©2009, The McGraw-Hill Companies, All Rights Reserved

OUTSTANDING BOND ISSUES

Сurrency Outstanding bond issues Cumulative volume

sovereign
PHP 84 3 974 896 787 020
USD 20 32 106 363 000
JPY 1 100 000 000 000
corporate
USD 106 79 249 218 000
AUD 24 9 076 600 000
EUR 10 2 550 000 000
NZD 9 1 821 000 000

MCGRAW-HILL/IRWIN 6-7

©2009, The McGraw-Hill Companies, All Rights Reserved

 TREASURY NOTES AND BONDS

Treasury
Treasury notes
notes and
and bonds
bonds (T-notes
(T-notes and
andT-
T-
bonds)
bonds) are
are issued
issued by
by the
the Government
GovernmentTreasury Treasury toto
finance
finance the
the national
national debt
debt and
and other
other government
government
expenditures
expenditures

The
The annual
annual budget
budget deficit
deficit isis equal
equal to to annual
annual
expenditures
expenditures (G)(G) less
less taxes
taxes (T)
(T) received
received

The
The national
national debtdebt (ND)
(ND) isis the
the sum
sum
N of
of historical
historical
annual
annual federal deficits: NDt  
federal deficits: t 1
(Gt  Tt )
MCGRAW-HILL/IRWIN 6-8

©2009, The McGraw-Hill Companies, All Rights Reserved

TREASURY NOTES AND BONDS
Default risk free: backed by
the full faith and credit of the
government
Interest rate risk: because of
their long maturity, T-notes
and T-bonds experience wider
price fluctuations than money
market securities when interest
rates change
MCGRAW-HILL/IRWIN
Low returns: low interest
rates (yields to maturity)
reflect low default risk
Liquidity risk: older issued T-
bonds and T-notes trade less
frequently than newly issued
T-bonds and T-notes
6-9
©2009, The McGraw-Hill Companies, All Rights Reserved
  T-notes have original maturities from over 1
to 10 years
 T-bonds have original maturities from over
10 years
 Issued in minimum denominations
(multiples) of $1,000
 May be either fixed principal or inflation-
TREASURY indexed
NOTES AND  inflation-indexed bonds are called
BONDS Treasury Inflation Protection
Securities (TIPS)
 the principal value of TIPS is adjusted by
the percentage change in the Consumer
Price Index (CPI) every six months
 Trade in very active secondary markets
 Prices are quoted as percentages of face
value, in 32nds
MCGRAW-HILL/IRWIN 6-10
©2009, The McGraw-Hill Companies, All Rights Reserved
 TREASURY STRIPS

Separate
SeparateTrading
Tradingof
ofRegistered
RegisteredInterest
Interestand
andPrincipal
Principal
Securities
Securities(STRIPS),
(STRIPS),a.k.a.
a.k.a.Treasury
Treasuryzero
zerobonds
bondsor orTreasury
Treasury
zero-coupon
zero-couponbonds
bonds

Financial
Financialinstitutions
institutionsand
andgovernment
governmentsecurities
securitiesbrokers
brokersand
and
dealers
dealerscreate
createSTRIPS
STRIPSfrom
fromT-notes
T-notesand
andT-bonds
T-bonds

STRIPS
STRIPShave
havethe
theperiodic
periodicinterest
interestpayments
paymentsseparated
separatedfrom
from
each
eachother
otherand
andfrom
fromthe
theprincipal
principalpayment
payment
 one set of securities reflects interest payments
one set of securities reflects interest payments
 one set of securities reflects principal payments
one set of securities reflects principal payments

STRIPS
STRIPSare
areused
usedto
toimmunize
immunizeagainst
againstinterest
interestrate
raterisk
risk
MCGRAW-HILL/IRWIN 6-11

©2009, The McGraw-Hill Companies, All Rights Reserved

 TREASURY NOTES AND BONDS

“Clean”
“Clean” prices
prices are
are calculated
calculated as: as:
INT
Vb  ( PVIFA id / m , Nm )  M ( PVIFid / m , Nm )
m
VVb ==the
thepresent
presentvalue
valueof
ofthe
thebond
bond
b

MM==the
thepar
parvalue
valueof
ofthe
thebond
bond
INT
INT==annual
annualinterest
interestpayment
payment(in
(indollars)
dollars)
NN==the
thenumber
numberof
ofyears
yearsuntil
untilthe
thebond
bondmatures
matures
mm==the
thenumber
numberof
oftimes
timesper
peryear
yearinterest
interestisispaid
paid
ii ==interest
d interestrate
rateused
usedtotodiscount
discountcash
cashflows
flowson
onthe
thebond
bond
MCGRAW-HILL/IRWIN
d 6-12

©2009, The McGraw-Hill Companies, All Rights Reserved

 TREASURY NOTES AND BONDS


Accrued
Accrued interest
interest on
onT-notes
T-notes and
andT-bonds
T-bonds isis
calculated
calculated as:
as:
INT Actual number of days since last coupon payment
Accrued interest  
2 Actual number of days in coupon period


The
The full
full (or
(ordirty)
dirty) price
price of
of aaT-note
T-note or
orT-bond
T-bond isis
the
the sum
sum of
of the
the clean
clean price
price (V
(Vbb)) and
and the
the accrued
accrued
interest
interest
MCGRAW-HILL/IRWIN 6-13

©2009, The McGraw-Hill Companies, All Rights Reserved

 TREASURY NOTES AND BONDS

The
The primary
primary market
market of
ofT-notes
T-notes and
andT-bonds
T-bonds isis
similar
similar to
to that
that of
ofT-bills;
T-bills; the
theTreasury
Treasury sells
sellsT-notes
T-notes
and
andT-bonds
T-bonds through
through competitive
competitive andand
noncompetitive
noncompetitive single-bid
single-bid auctions
auctions

2-year
2-yearnotes
notesare
areauctioned
auctionedmonthly
monthly

3,
3,5,
5,and
and10-year
10-yearnotes
notesare
areauctioned
auctionedquarterly
quarterly(Feb,
(Feb,
May,
May,Aug,
Aug,and
andNov)
Nov)

30-year
30-yearbonds
bondsare
areauctioned
auctionedsemi-annually
semi-annually(Feb
(Feband
and
Aug)
Aug)

Most
Most secondary
secondary trading
trading occurs
occurs directly
directly through
through
brokers
brokers and
and dealers
dealers
MCGRAW-HILL/IRWIN 6-14

©2009, The McGraw-Hill Companies, All Rights Reserved

MUNICIPAL BONDS

Municipal
Municipalbonds
bonds(Munis)
(Munis)are
aresecurities
securitiesissued
issuedby
bystate
stateand
and
local
localgovernments
governments
 to fund imbalances between expenditures and receipts
to fund imbalances between expenditures and receipts
 to finance long-term capital outlays
to finance long-term capital outlays

Attractive
Attractiveto
tohousehold
householdinvestors
investorsbecause
becauseinterest
interestisisexempt
exempt
from
fromfederal
federalandandmost
mostlocal
localincome
incometaxes
taxes

General
Generalobligation
obligation(GO)
(GO)bonds
bondsare
arebacked
backedbybythe
thefull
fullfaith
faith
and
andcredit
creditof ofthe
theissuing
issuingmunicipality
municipality

Revenue
Revenuebondsbondsare aresold
soldto
tofinance
financespecific
specificrevenue
revenue
generating
generatingprojects
projects
MCGRAW-HILL/IRWIN 6-15

©2009, The McGraw-Hill Companies, All Rights Reserved

MUNICIPAL BONDS IN THE
PHILIPPINES

 Our local government units are expressly authorized to

issue bonds, debentures, securities, collateral notes and
other obligations to finance self-liquidating, income-
producing development and livelihood projects.
 As early as 1998, the Bankers Association of the
Philippines and the Development Bank of the Philippines
created the Local Government Unit Guarantee Corporation
(LGUGC) to facilitate LGU bond floatation. Even before
the creation of the LGUGC, there were municipal bond
flotation—although very few—in the market.
MCGRAW-HILL/IRWIN 6-16

©2009, The McGraw-Hill Companies, All Rights Reserved

The LGUGC was the first privately managed
local government guarantee corporation set up in
a developing country in Asia.
Among the LGUGC-guaranteed LGU bonds
were those issued by the cities of Caloocan and
Tagaytay; Puerto Princesa and the Municipality
of Infanta.
MCGRAW-HILL/IRWIN 6-17

©2009, The McGraw-Hill Companies, All Rights Reserved

But while we were the first in Asia to come up
with this initiative, our municipal bond market
has not been fully developed and utilized as a
tool of economic development at the local level.
As a matter of fact, the records of the LGUGC
would readily indicate that there have only been
a handful of LGU bond issuances. The
LGUGC guarantees more bank loans than bond
6-18
floatation by our LGUs.
MCGRAW-HILL/IRWIN

©2009, The McGraw-Hill Companies, All Rights Reserved

 MUNICIPAL BONDS

Compare
Compare Muni
Muni returns
returns with
with fully
fully taxable
taxable corporate
corporate
bonds
bonds by
by finding
finding the the after-tax
after-tax return
return for
for corporate
corporate
bonds:
bonds: iiaa == iibb(1
(1 –– t)t)
iai ==after-tax
after-taxrate
rateof
ofreturn
returnon
onaataxable
taxablecorporate
corporatebond
bond
a

ibi ==before-tax
before-taxrate
rateof
ofreturn
returnon
onaataxable
taxablebond
bond
b

tt==marginal
marginaltotal
totalincome
incometax
taxrate
rateof
ofthe
thebond
bondholder
holder

Alternately,
Alternately, convert
convert Muni
Muni interest
interest rates
rates to
to tax
tax
equivalent
equivalent rates
rates of
of return:
return: iibb == iiaa/(1
/(1 –– t)t)
MCGRAW-HILL/IRWIN 6-19

©2009, The McGraw-Hill Companies, All Rights Reserved

 MUNICIPAL BONDS

Primary
Primarymarkets
markets
 firm commitment underwriting: a public offering of Munis made
firm commitment underwriting: a public offering of Munis made
through
throughananinvestment
investmentbank,bank,where
wherethe
theinvestment
investmentbank
bankguarantees
guarantees
aaprice
pricefor
forthe
thenewly
newlyissued
issuedbonds
bondsbybybuying
buyingthe
theentire
entireissue
issueand
and
then
thenreselling
resellingitittotothe
thepublic
public
 best efforts offering: a public offering in which the investment
best efforts offering: a public offering in which the investment
bank
bankdoes
doesnot
notguarantee
guaranteeaafirm
firmprice
price
 private placement: bonds are sold on a semi-private basis to
private placement: bonds are sold on a semi-private basis to
qualified
qualifiedinvestors
investors(generally
(generallyFIs)
FIs)

Secondary
Secondarymarkets:
markets:Munis
Munistrade
tradeinfrequently
infrequentlydue
duemainly
mainly
to
toaalack
lackof
ofinformation
informationon
onbond
bondissuers
issuers
MCGRAW-HILL/IRWIN 6-20

©2009, The McGraw-Hill Companies, All Rights Reserved

 CORPORATE BONDS

Corporate
Corporate bonds
bonds are
are long-term
long-term bonds
bonds issued
issued by
by
corporations
corporations

A Abond
bond indenture
indenture isis the
the legal
legal contract
contract that
that
specifies
specifies the
the rights
rights and
and obligations
obligations ofof the
the issuer
issuer
and
and the
the holders
holders

Bearer
Bearer versus
versus registered
registered bonds
bonds

Term
Term versus
versus serial
serial bonds
bonds

Mortgage
Mortgage bonds
bonds are
are secured
secured debt
debt issues
issues
MCGRAW-HILL/IRWIN 6-21

©2009, The McGraw-Hill Companies, All Rights Reserved

CORPORATE BONDS
BEARER VERSUS REGISTERED BONDS
REGISTERED BONDS
Bearer
Bearerbonds
bonds

debt instrument whose
 fixed-income security that is owned
fixed-income security that is owned
bondholder's information is
by
bythe
theholder,
holder,or
orbearer,
bearer,rather
ratherthan
than kept on record with the issuing
by a registered owner.
by a registered owner. party.
 The coupons for interest payments  By archiving the owner's
The coupons for interest payments
are
arephysically
physicallyattached
attachedto
tothe
the
security.
name, address, and other
security.
 The bondholder is required to details, issuers ensure they're
The bondholder is required to making the bond's coupon
submit
submitthe
thecoupons
couponsto toaabank
bankfor
for
payment
paymentand andthen
thenredeem
redeemthethe
payments to the correct
physical
physicalcertificate
certificatewhen
whenthethebond
bond person.
reaches
reachesthe
thematurity
maturitydate.
date.
MCGRAW-HILL/IRWIN 6-22

©2009, The McGraw-Hill Companies, All Rights Reserved

CORPORATE BONDS
TERM VERSUS SERIAL BONDS

TERM BONDS SERIAL BONDS

notes issued by  a bond issue that is structured so
that a portion of the
companies to the outstanding bonds mature at
regular intervals until all of the
public or investors bonds have matured.

with  Because the bonds mature

gradually over a period of years,
scheduled maturity these bonds are used to finance
projects that provide a consistent
dates. income stream for bond repayment.
MCGRAW-HILL/IRWIN 6-23

©2009, The McGraw-Hill Companies, All Rights Reserved

 CORPORATE BONDS
MORTGAGE BONDS

 mortgage

mortgage bond
bond is
is secured
secured by
by aa
mortgage,
mortgage, oror aa pool
pool of
of mortgages,
mortgages,
that
that are
are typically
typically backed
backed byby real
real
estate
estate holdings
holdings andand real
real property,
property,
such
such as
as equipment.
equipment.
MCGRAW-HILL/IRWIN 6-24

©2009, The McGraw-Hill Companies, All Rights Reserved

CORPORATE BONDS

Debentures
Debentures and
and subordinated
subordinated debentures
debentures

Convertible
Convertible bonds
bonds versus
versus non-convertible
non-convertible bonds
bonds
icvb  incvb  opcvb
icvb
i ==rate
rateof
ofreturn
returnon
onaaconvertible
convertiblebond
bond
cvb

incvb
i ==rate
rateof
ofreturn
returnon
onaanonconvertible
nonconvertiblebond
bond
ncvb

op
opcvb = value of the conversion option
cvb = value of the conversion option


Stock
Stock warrants
warrants give
give bondholders
bondholders the
the opportunity
opportunity
to
to purchase
purchase common
common stock
stock at
at aa prespecified
prespecified price
price
MCGRAW-HILL/IRWIN 6-25

©2009, The McGraw-Hill Companies, All Rights Reserved

CORPORATE BONDS
Debentures
Debentures
aatype
typeof
ofbond
bondororother
otherdebt
debtinstrument
instrumentthat
thatisisunsecured
unsecured
by
bycollateral.
collateral.
Subordinated
Subordinated debentures
debentures
isisan
anunsecured
unsecuredloan
loanor
orbond
bondthat
thatranks
ranksbelow
belowother,
other,more
more
senior
seniorloans
loansororsecurities
securitieswith
withrespect
respectto
toclaims
claimsononassets
assetsor
or
earnings.
earnings.
Subordinated debentures are thus also known as junior
Subordinated debentures are thus also known as junior
securities.
securities.InInthe
thecase
caseof
ofborrower
borrowerdefault,
default,creditors
creditorswho
whoown
own
subordinated
subordinateddebt debtwill
willnot
notbebepaid
paidout
outuntil
untilafter
aftersenior
senior
bondholders
bondholdersare arepaid
paidin
infull.
full.
MCGRAW-HILL/IRWIN 6-26

©2009, The McGraw-Hill Companies, All Rights Reserved

CORPORATE BONDS
Callable
Callablebonds
bonds

also
alsoknown
knownasasaaredeemable
redeemablebond,
bond,isisaabond
bondthat
thatthe
the
issuer
issuermay
mayredeem
redeembefore
beforeititreaches
reachesthe
thestated
statedmaturity
maturity
date.
date.

AAcallable
callablebond
bondallows
allowsthe
theissuing
issuingcompany
companyto topay
payoff
off
their
theirdebt
debtearly
early
Non-callable
Non-callable bonds
bonds
 bond
 bondthatthatisisonly
onlypaid
paidout
outatatmaturity.
maturity.The
Theissuer
issuerofofaa
non-callable
non-callablebond bondcan’t
can’tcall
callthe
thebond
bondprior
priorto
toits
itsdate
date
of
ofmaturity.
maturity.
MCGRAW-HILL/IRWIN 6-27

©2009, The McGraw-Hill Companies, All Rights Reserved

 CORPORATE BONDS


AASinking
Sinking fund
fund provision
provision isis aa requirement
requirement that
that
the
the issuer
issuer retire
retire aa certain
certain amount
amount of
of the
the bond
bond issue
issue
early
early as
as the
the bonds
bonds approach
approach maturity.
maturity.

MCGRAW-HILL/IRWIN
6-28

©2009, The McGraw-Hill Companies, All Rights Reserved

 CORPORATE BONDS

Primary
Primarymarkets
marketsare
areidentical
identicalto
tothat
thatof
ofMunis
Munis

Secondary
Secondarymarkets
markets
 the
theexchange
exchangemarket
market(e.g.,
(e.g.,PSE,
PSE,NYSE)
NYSE)
 the
theover-the-counter
over-the-counter(OTC)
(OTC)market
market

Bond
Bondratings
ratings
 the
thetwo
twomajor
majorbond
bondrating
ratingagencies
agenciesare
areMoody’s
Moody’sand
and
Standard
Standard& &Poor’s
Poor’s(S&P)
(S&P)
 bonds
bondsare
arerated
ratedby
byperceived
perceiveddefault
defaultrisk
risk
 bonds
bondsmay
maybe
beeither
eitherinvestment
investmentor
orspeculative
speculative(i.e.,
(i.e.,junk)
junk)
grade
grade
MCGRAW-HILL/IRWIN 6-29

©2009, The McGraw-Hill Companies, All Rights Reserved

 BOND MARKET INDEXES


Managed
Managed by
by major
major investment
investment banks
banks

Reflect
Reflect both
both the
the monthly
monthly capital
capital gain
gain and
and loss
loss on
on
bonds
bonds plus
plus any
any interest
interest (coupon)
(coupon) income
income earned
earned

Changes
Changes in in values
values ofof bond
bond indexes
indexes can
can bebe used
used by
by
bond
bond traders
traders to
to evaluate
evaluate changes
changes inin the
the investment
investment
attractiveness
attractiveness ofof bonds
bonds ofof different
different types
types and
and
maturities
maturities
MCGRAW-HILL/IRWIN 6-30

©2009, The McGraw-Hill Companies, All Rights Reserved

 BOND MARKET PARTICIPANTS

The
Themajor
majorissuers
issuersof
ofdebt
debtmarket
marketsecurities
securitiesare
arefederal,
federal,
state
stateand
andlocal
localgovernments,
governments,and
andcorporations
corporations

The
Themajor
majorpurchasers
purchasersof
ofcapital
capitalmarket
marketsecurities
securitiesare
are
households,
households,businesses,
businesses,government
governmentunits,
units,and
andforeign
foreign
investors
investors
 businesses and financial firms (e.g., banks, insurance companies,
businesses and financial firms (e.g., banks, insurance companies,
and
andmutual
mutualfunds)
funds)are
arethe
themajor
majorsuppliers
suppliersof
offunds
fundsfor
forMunis
Munisand
and
corporate
corporatebonds
bonds
 foreign investors and governments are the major suppliers of funds
foreign investors and governments are the major suppliers of funds
for
forT-notes
T-notesand
andT-bonds
T-bonds
MCGRAW-HILL/IRWIN 6-31

©2009, The McGraw-Hill Companies, All Rights Reserved

 INTERNATIONAL BONDS AND
MARKETS
 International bond markets involve unregistered bonds that are
International bond markets involve unregistered bonds that are
internationally
internationallysyndicated,
syndicated,offered
offeredsimultaneously
simultaneouslytotoinvestors
investorsinin
several
severalcountries,
countries,and
andissued
issuedoutside
outsideof
ofthe
thejurisdiction
jurisdictionof
ofany
anysingle
single
country
country
 Eurobonds are long-term bonds issued outside the country of the
Eurobonds are long-term bonds issued outside the country of the
currency
currencyininwhich
whichthey
theyare
aredenominated
denominated
 Foreign Bonds are long-term bonds issued outside of the issuer’s
Foreign Bonds are long-term bonds issued outside of the issuer’s
home
homecountry
country
 Brady Bonds are bonds swapped for an outstanding loan to a less
Brady Bonds are bonds swapped for an outstanding loan to a less
developed
developedcountry
country
 Sovereign Bonds are Brady Bonds that have had their underlying
Sovereign Bonds are Brady Bonds that have had their underlying
collateral
collateralremoved
removedand andthe
thecreditworthiness
creditworthinessofofthe
thecountry
countryisis
substituted
substitutedinstead
instead
MCGRAW-HILL/IRWIN 6-32

©2009, The McGraw-Hill Companies, All Rights Reserved

Proverbs 10:9
Whoever walks in integrity walks
securely, but whoever takes the crooked
path shall be found out.

MCGRAW-HILL/IRWIN 6-33

©2009, The McGraw-Hill Companies, All Rights Reserved