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Introduction to Bond Markets

Introduction to Bond Markets

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Introduction to Bond Markets

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  1. Introduction to Bond Markets Investments and Portfolio Management MB 72

  2. Outline • Bond Markets Before 1980s and Bond Markets now • What are fixed-income securities? • Participants/Players • Meaning of a Bond • Features of a Bond • Types of Bonds • Sources of Risk and Return in Debt Securities • Regulation of Fixed Income Securities

  3. Why a Separate Course on Fixed Income Securities? • Markets Prior to 1980s • Dominated by plain vanilla bonds with simple cash flow structures • Valuation was simple and straightforward • Markets After 1980s • Complex cash flow structures • A variety of securities • Derivative products to facilitate portfolio strategies to control interest rate risk and to enhance return • Wider range of investors

  4. Two thirds of the market value of all the securities outstanding in world classified as fixed income • Most participants in the corporate and financial sectors participate in this market • Federal governments, state governments, and municipalities have not choice but to issue fixed income securities • Therefore, a need to have well informed participants so that they understand • the forces that drive the bond market • The valuation of complex cash flow structures • Portfolio management strategies

  5. Meaning of a Bond • A debt instrument requiring the issuer also called the debtor or borrower to repay to the lender/investor the amount borrowed plus interest over some specified period of time • A typical “plain vanilla” bond issued in the U.S. specifies • A fixed date when the amount borrowed is due • The contractual amount of interest, which is typically paid every six months • Cash flow pattern is know assuming no default

  6. Features of a Bond • Face Value • Maturity • Yield • Callable/Non-callable • Refunding Provisions • Provisions for paying off bonds

  7. Types of Bonds • Zero Coupon Bonds • Floating Rate Bonds • Callable Bonds • Convertibles

  8. Risks of Bonds • Interest Rate Risk • Reinvestment Risk • Call Risk • Default Risk • Inflation Risk • Exchange Rate Risk • Liquidity Risk

  9. Regulation of Bond Markets • Largely self-regulated • Federal Reserve and the SEC closely follow this market • By and large this market is left to operate on its own • Three major institutions oversee the regulation of the market: • The U.S. Treasury • The Federal Reserve • The Securities and Exchange Commission • Goal is to improve market transparency and access to information for all participants