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Basic Features of a Bond

Basic Features of a Bond. Pay a fixed amount of interest periodically to the holder of record Repay a fixed amount of principal at the date of maturity. Basic Features of a Bond. Bond market is divided by maturity Money Market - short-term issues that mature within one year

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Basic Features of a Bond

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  1. Basic Features of a Bond • Pay a fixed amount of interest periodically to the holder of record • Repay a fixed amount of principal at the date of maturity

  2. Basic Features of a Bond • Bond market is divided by maturity • Money Market - short-term issues that mature within one year • Notes - intermediate-term issues that mature between one and ten years • Bonds - long-term obligations with maturity greater than ten years • Remaining life (maturity) affect price volatility

  3. Bond Characteristics • Intrinsic features • Coupon - yield (interest income) • Maturity - term or serial (municipalities) • Principal value - different from market value • Type of ownership - bearer or registered • Types of Issues • Secured (senior) bonds • Unsecured bonds (debentures) • Subordinated (junior) debentures

  4. Bond Characteristics • Indenture provisions • Features affecting a bond’s maturity • Callable (call premium) • Noncallable • Deferred call • Nonrefunding provision • Sinking fund

  5. Rates of Return on Bonds where: HPRi,t = the holding period for bond i during the period t Pi,t+1 = the market price of bond i at the end of period t Pi,t = the market price of bond i at the beginning of period t Inti,t = the interest payments on bond i during period t The holding period yield (HPY) is: HPY = HPR - 1

  6. The Global Bond-Market Structure • Participating issuers • 1. Federal governments • 2. Agencies of the federal government • 3. State and local political subdivisions (municipalities) • 4. Corporations • 5. International issues • Foreign bonds • Eurobonds

  7. Participating Investors • Individual investors • Institutional investors • Life Insurance Companies • Commercial Banks • Property and Liability Insurance Companies • Pension Funds • Mutual Funds

  8. Bond Ratings Major Rating Agencies • Standard & Poor’s • Moody’s • Fitch Investor Services

  9. Alternative Bond Issues Domestic government bonds • United States - T-bills, notes, bonds. TIPS • Japan - medium term, long term, super long term • Eurozone – government bonds • United Kingdom - short gilts, medium gilts, long gilts

  10. Government Agency Issues United States • Not direct issues, but backed by “full faith and credit” of the U.S. government • GNMA pass-through certificates Japan • Government associate organizations United Kingdom • There are no agency bonds in the U.K. Eurozone • Agency bonds are not broken down in the Eurozone

  11. Municipal Bonds • General obligation (GO) bonds • Revenue bonds • Interest payments are exempt from federal income tax • Convert the tax-free yield of a municipal bond selling close to par to an equivalent taxable yield (ETY)

  12. Equivalent Taxable Yield Where: i = coupon rate of the municipal obligations T = marginal tax rate of the investor

  13. Municipal Bond Guarantees • Bond insured against default risk • Insurance is irrevocable for the life of the issue • Four private bond insurance carriers • Municipal Bond Investors Assurance (MBIA) • American Municipal Bond Assurance Corporation (AMBAC) • Financial Security Assurance • Financial Guaranty Insurance Company (FGIC)

  14. Municipal Bond Guarantees • Insured bonds obtain AAA (Aaa) ratings • Issues with private guarantees have more active secondary market, and lower required yield

  15. Corporate Bonds • Mortgage bonds • Collateral trust bonds • Equipment trust certificates • Collateralized mortgage obligations (CMOs) • Other asset-backed securities (ABS) • Variable rate notes

  16. Corporate Bonds • Zero-coupon and deep-discount bonds • Minicoupon bonds • Original-issue discount (OID) bonds • Taxes due on the implied interest • High-yield bonds (speculative bonds and junk bonds) • Noninvestment grade with rating below BBB or Baa

  17. Japanese Corporate Bond Market • Bonds issued by industrial firms or utilities • Minimum issuing requirements are specified by the Ministry of Finance • Bonds issued by banks to finance loans to corporation • Commercial banks • Long-term credit banks • Mutual loan and savings banks • Specialized financial institutions

  18. U.K. Corporate Bond Market • Debentures • Unsecured loans • Convertible bonds

  19. Eurozone Corporate Bond Market • Nonbank corporate bonds including industrial and utility firms • “Corporate-monetary Financial” including borrowing by banks

  20. International Bonds • Foreign bonds are sold in one country and currency by a borrower of a different nationality • Yankee bonds are U.S. dollar denominated bonds sold in the U.S. but issued by a foreign firm • Eurobonds are underwritten by international bond syndicates and sold in several national markets

  21. International Bonds • United States • Yankee bonds register with SEC • Eurodollar bond market affected by changes in value of U.S. dollar • Japan • Samuri bonds - yen denominated issued by non-Japanese firms in Japan • Euroyen bonds - yen denominated, sold outside Japan • United Kingdom • Bulldog bonds are sterling-denominated bonds issued by non-English firms and sold in London • Eurosterling bonds are sold in markets outside London by international syndicates • Eurozone • Market popular among foreign issuers including issuers domiciled in the U.S. • Impressive growth in Eurobonds issued by non-residents

  22. Obtaining Information on Bonds • Less emphasis on fundamental analysis • Most bond investors rely on rating agencies for credit analysis • Market and economic conditions • Intrinsic bond features • Popular publications available: • Wall Street Journal, Barron’s, Business Week, Fortune, Forbes, Federal Reserve Bulletin, Survey of Current Business

  23. Interpreting Bond Quotes • Quoted on basis of yield or price • Price quotes are percentage of par • 98 1/2 is not $98.50 but 98.5% of par • A municipal $5,000 bond quoted at 98 1/2 would be $4,925

  24. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645

  25. Corporate Bond Quotes CompanyLast Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford7.45July 162031 80.625 9.461 50330 213,645 Issued by Ford Motor Company

  26. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645 The maturity date of this bond

  27. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645 The last transaction price was 80.625 percent of par or $806.25, which implies an yield to maturity (YTM) for this bond of 9.461 percent

  28. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645 The computed yield spread for the Ford bond is 503 basis points (5.03 basis points)

  29. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645 Comparable U.S. treasury Issue

  30. Corporate Bond Quotes Company Last Last EST UST EST $ (Ticker) Price Yield Spread VOL Ford 7.45July 162031 80.625 9.461 50330 213,645 The trading volume for this bond is over $213 million

  31. Treasury and Agency Bond Quotes • Notations • “n” = treasury note • “i” = inflation-indexed issue • “p” = treasury note on which nonresident aliens are exempt from withholding taxes on interest • Quotes resemble those used for OTC securities because they contain both bid and ask prices

  32. Treasury and Agency Bond Quotes GOVT. BONDS & NOTES Maturity Ask Rate Mo/Yr Bid Asked Chg. Yld. 5.750 Nov 05n 101:05 101:06 …. 3.13

  33. Treasury and Agency Bond Quotes GOVT. BONDS & NOTES Maturity Ask Rate Mo/Yr Bid Asked Chg. Yld. 5.750 Nov 05n 101:05 101:06 …. 3.13 This is a 5.75 percent obligation bond due in November 2005. The bid quote is 101:05, and the ask is 101:06

  34. Treasury and Agency Bond Quotes • U.S. Treasury Strips • “ci” is the coupon interest portion stripped from the note • “np” is the principal payment for the treasury note • Treasury Bills • Pure discount instrument - there is no coupon, they pay par at maturity • The bid-ask is not the price but the yield

  35. Municipal Bond Quotes Quote from The Blue List of Current Municipal Offerings $200,000 of Indiana State Office Building bonds Guaranteed by MBIA These are zero coupon bonds due July 1, 2010 The yield to maturity is given as 5.6% To determine the price you compute the discount value The dealer offering the bonds is Bear Sterns, listed in the back of the publication with their phone number 200 INDIANA ST OFFICE BLDG COMMN MBIA 0.000 07/01/10 5.60 BEARSTER

  36. Municipal Bond Quotes • Notations ETM = escrow till maturity M/S/F = mandatory sinking fund (C97) = this bond became callable in 1997 When the market yield equals the coupon rate, the price is 100 and they are referred to as dollar bonds “+” in the left column indicates a new item “#” before yield to maturity or price indicates a change

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