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Copyright 2015 Diane Scott Docking 1
The Bond Market
My name is Bond,
Corporate Bond.
2Copyright 2015 Diane Scott Docking
Learning Objectives
Describe the major bond markets Know the various types of bonds in each market Know how to read a published Bond Quote Compute the various bond components Describe various types of foreign bonds
3Copyright 2015 Diane Scott Docking
3 major Types of Bonds
Types of Bonds Treasury Notes and Bonds Municipal Bonds Corporate Notes and Bonds
The Treasury & Agencies Securities Market
Copyright 2015 Diane Scott Docking 4
Copyright 2015 Diane Scott Docking 5
U. S. Treasury Bonds Issued by the U.S. Treasury to finance federal government
expenditures Maturity
> 1 year < 10 Years
> 10
________________ Interest Payments Denominations are in multiples of $ . Active Secondary Market Benchmark Debt Security for Any Maturity Prices are stated as % of par Interest yields are computed on a 365-day basis
Copyright 2015 Diane Scott Docking 6
Example: T-Bond Quote (at July 22,
2015)
Ask
Maturity Coupon Bid Asked Chg Yield
6/30/2017 2.500 103.4688 103.4844 -0.0156 0.686
Coupon Rate (intervals of 1/8%)
n: Note YTM %Selling at 100+ % of par
% of 100% rounded
http://online.wsj.com/mdc/public/page/2_3020-treasury.html?mod=topnav_2_3021#treasuryA
Change from yesterday’s asked
Copyright 2015 Diane Scott Docking 7
Example: T-Bond Quote (at July 22,
2015)
Ask
Maturity Coupon Bid Asked Chg Yield
6/30/2017 2.500 103.4688 103.4844 -0.0156 0.686
1) Interest received is: 2.50% x $1,000 = $25 annually or $12.50 semi-annually
2) Purchase price: PP = (Asked/100) x Face
PP =103.4844% x $1,000 = $1,034.844
3) YTM = is a good approximation of Ask Yield because Asked Quote is rounded.
FV=1,000
PV=1,034.844
PMT=12.50
N=707 days /365 yrs. x 2 = 1.936986301 x 2 = 3.873972603
CPT i/y= 0.343030248 x 2 = 0.686060497 = 0.686% (good)
0.686%
8Copyright 2015 Diane Scott Docking
Treasury Notes and Bonds
“Clean” prices are calculated as:
Vb = the present value of the bond
M = the par value of the bond
INT = annual interest payment (in dollars)
N = the number of years until the bond matures
m = the number of times per year interest is paid
id = interest rate used to discount cash flows on the bond
“Clean” prices are calculated as:
Vb = the present value of the bond
M = the par value of the bond
INT = annual interest payment (in dollars)
N = the number of years until the bond matures
m = the number of times per year interest is paid
id = interest rate used to discount cash flows on the bond
)()( ,/,/ NmmidNmmidb PVIFMPVIFAm
INTV
9Copyright 2015 Diane Scott Docking
Treasury Notes and Bonds Accrued interest on T-notes and T-bonds is
calculated as:
The full (or dirty) price of a T-note or T-bond is the sum of the clean price (Vb) and the accrued interest
Accrued interest on T-notes and T-bonds is calculated as:
The full (or dirty) price of a T-note or T-bond is the sum of the clean price (Vb) and the accrued interest
periodcoupon in days ofnumber Actual
paymentcoupon last since days ofnumber Actual
2Face interest Accrued
INT
Last coupon date Settlement date Next coupon date
No count No count Count Count
Days since last coupon payment Days to next coupon payment
Days in coupon period
Copyright 2015 Diane Scott Docking 10
Example: Accrued Interest
On August 5, 2015 you purchase a $10,000 T-note that matures May 15, 2021. Settlement is August 7, 2015. Coupon rate is 5.875%. Current T-note price quote is 101.3438. The last coupon payment occurred on May 15, 2015 and next coupon will be paid November 15, 2015.
What is the accrued interest due to the seller from the buyer at settlement?
What is the dirty price of this T-note? What is the YTM (based on clean price) of this note?
Copyright 2015 Diane Scott Docking 11
Solution to Example: Accrued InterestGiven:
Purchase on August 5, 2015
Settlement is August 7, 2015
$10,000 T-note, May 15, 2021, 5.875% coupon
Current T-note price quote is 101.3438
Last coupon payment May 15, 2015
Next coupon payment November 15, 2015.
Current price = 101.3438% x $10,000 = $10,134.38
Last coupon payment on May 15, 2015 occurred 83 days before settlement:
May June July Aug
16 + 30 + 31 + 6 = 83
Next coupon payment on Nov. 15, 2015 occurs 101 days after settlement:
Aug Sept Oct Nov
25 + 30 + 31 + 15 = 101
Days in coupon period from on May 15, 2015 - Nov. 15, 2015:
May June July Aug Sept Oct Nov
16 + 30 + 31 + 31 + 30 + 31 + 15 = 184 days
Copyright 2015 Diane Scott Docking 12
Solution to Example: Accrued InterestAccrued interest due to the seller from the buyer at settlement?
What is the dirty price of this T-note?Clean Price + Accrued interest = Dirty Price
$10,134.38+ 132.51 = ______________
51.132$184
8375.293$
184
83
2
%875.5$10,000 interest Accrued
periodcoupon in days ofnumber Actual
paymentcoupon last since days ofnumber Actual
2Face interest Accrued
INT
Copyright 2015 Diane Scott Docking 13
Solution to Example: Accrued InterestWhat is the YTM (based on clean price) of this note?
FV = $10,000
PV = $10,134.38 (clean price)
Pmt = $293.75 ($10,000 x .05875 = 587.50 / 2 = 293.75)
n = 2,108 days (Aug. 8, 2015 – May 15, 2021)
2,108/365 = 5.775342466 years (convert to fraction of years)
5.775342466 x 2 = 11.55068493
i/y = YTM = 2.799729823 x 2 = 5.599459646% = 5.599%
Copyright 2015 Diane Scott Docking 14
Special Treasury Bonds
Zero-coupon securities are sold with claims on U. S. Treasury bonds held in a trust One security represents the principal payment (np or bp) at
maturity (note principal or bond principal) Other securities represents the interest payments (ci) at
interest paying dates (coupon interest)
http://wsj.com/mdc/public/page/2_3020-tstrips.html
Stripped Treasury Bonds
Copyright 2015 Diane Scott Docking 15
Example: Treasury Strips
Friday, July 24, 2015:
Treasury Bond, Stripped Principal
Maturity Bid Asked Chg Asked
yield
2020 Aug 15 91.743 91.789 0.079 1.70
Stripped Coupon Interest
Maturity Bid Asked Chg Asked
yield
2017 Feb 15 99.079 99.094 0.031 0.59
2020 Aug 15 91.528 91.574 0.002 1.75
1) Verify the Asked Yield on the 2020 Stripped Principal. Assume settlement on Monday, July 27, 2015.
2) Verify the Asked Price on the 2020 Stripped Coupon Interest. Assume settlement on Monday, July 27, 2015.
Copyright 2015 Diane Scott Docking 16
Bid and AskedQuotes are a % of 100
Example: Treasury Strips
Verify Asked Yield
Tuesday, July 24, 2015:
Treasury Bond, Stripped Principal
Maturity Bid Asked Chg Asked
yield
2020 Aug 15 91.743 91.789 0.079 1.70
FV = $1,000
PV = 91.789% x 1,000 = $917.89
Pmt = $0
n = 1,844* days / 365 = 5.052054795 yrs. X 2 = 10.10410959
(need to multiply “n” x 2 since the original T-Bond was a “semi-annual” security.
Compute: i/y = 0.85155452% x 2 = 1.703109041% = 1.70%
(multiply times 2 to annualize the rate).
* Do not count settlement date
Copyright 2015 Diane Scott Docking 17
Example: Treasury Strips
Verify Asked Price
Tuesday, July 24, 2015 :
Stripped Coupon Interest
Maturity Bid Asked Chg Asked
yield
2020 Aug 15 91.528 91.574 0.002 1.75
FV = $1,000
i = 1.75% / 2 = 0.695%
Pmt = $0
n = 1,844* days / 365 = 5.052054795 yrs. X 2 = 10.10410959
(need to multiply “n” x 2 since the original T-Bond was a “semi-annual” security.
i/y = 1.75% / 2 = 0.875% (divide Asked yield by 2).
Compute PV = 915.7367 = 91.574 (good)
* Do not count settlement date
Copyright 2015 Diane Scott Docking 18
Copyright 2015 Diane Scott Docking 19
Special Treasury Bonds
TIPS – Treasury Inflation Protection Securities Intended for investors who seek inflation protection with their
investments Coupon rates less than other Treasuries Principal value adjusted for the U.S. inflation rate (CPI) every 6
months Coupon income increases with inflation
http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm
Inflation-Indexed Bonds
Copyright 2015 Diane Scott Docking 20
Example: TIPs
An investor purchases $5 million of par value TIPS. The real rate (determined at the auction) is 2.4% (coupon rate). Assume at the end of the first 6 months the CPI-U = 3% (annual rate) and at the end of the second 6 months the CPI-U = 3.8% (annual rate).
Compute the following:1. Inflation adjusted principal at end of first 6 months,
2. Coupon payment made at end of first 6 months,
3. Inflation adjusted principal at end of second 6 months,
4. Coupon payment made at end of second 6 months
Copyright 2015 Diane Scott Docking 21
Example: TIPs1. Inflation adjusted principal at end of first 6 months:
$5 mill. x (1 + (.03/2)) = $5 mill x 1.015 = _______________
2. Coupon payment made at end of first 6 months:
$5,075,000 x (.024/2) = $5,075,000 x (.012) = _______________
3. Inflation adjusted principal at end of second 6 months:
$5,075,000 mill. x (1 + (.038/2)) = $5,075,000 x 1.019 = _____________
4. Coupon payment made at end of second 6 months:
$5,171,425 x (.024/2) = $5,171,425 x (.012) = _______________
Copyright 2015 Diane Scott Docking 22
MARKET FOR U.S. TREASURY SECURITIESThe Primary Market Auction cycle
Treasury securities are issued on an auction basis For coupon securities, the government holds
monthly 2-year note and 5-year note auctions, and quarterly auctions for the 10-year note
Copyright 2015 Diane Scott Docking 23
Copyright 2015 Diane Scott Docking 24
Copyright 2015 Diane Scott Docking 25
Copyright 2015 Diane Scott Docking 26
T-Bond or T-Note Primary Auction
All non-competitive bids accepted.
Specify quantity only.
Maximum bid . Price is the competitive auction
yield price. Investors do not know the
price in advance so they submit check for full par value
After the auction, investor receives check from the Treasury covering the difference between par and the actual price
Specify price (as a yield %) and quantity desired.
Minimum purchase $100 Single price auction used since
1998 Treasury accepts highest bids
prices (lowest bid yields) Maximum amount sold to any
one buyer is 35% of offering amount
http://www.treasurydirect.gov/instit/auctfund/work/work.htm
Noncompetitive Bidding Competitive Bidding
Copyright 2015 Diane Scott Docking 27
Problem 1: T-Note/Bond AuctionThe Treasury is auctioning off $120 million in 5-year T-notes. The following
bids are received:
Noncompetitive bids: $10 millionCompetitive bids: bid yield
Dealer J $ 1 mill. 4.000%Dealer K $ 5 mill. 4.252% Dealer L $20 mill. 5.000%Dealer M $50 mill. 5.500%Dealer N $ 4 mill. 5.752%Dealer O $10 mill. 6.100%Dealer P $40 mill. 6.100%Dealer Q $60 mill. 6.400%
Copyright 2015 Diane Scott Docking 28
Solution: T-Note/Bond Auction1. Which dealers will have their bids filled? By how much?
Total auction = $120 million (x 35% = $42 mill. bid limit) - Noncompetitive bids - 10 million Avail. for comp. bids $110 million
Competitive bids:Dealer Bid yld Amt. Bid Amt. Accepted Total Accepted J 4.000% $ 1 mill. $ 1 mill. $ 1 mill. K 4.252% $ 5 mill. $ 5 mill. $ 6 mill. L 5.000% $ 20 mill. $ 20 mill.$ 26 mill. M 5.500% $ 50 mill. $ 42 mill.$ 68 mill. N 5.752% $ 4 mill. $ 4 mill. $ 72 mill. O 6.100% $ 10 mill. $ 7.6 mill. $ 79.6 mill. P 6.100% $ 40 mill. $ 30.4 mill. $110 mill. Q 6.400% $ 60 mill. __-0-___
Total $190 mill. $110 mill.
Copyright 2015 Diane Scott Docking 29
Solution: T-Note/Bond Auction2. What is the “stopout rate” or “stop yield” or “high
yield”?The highest rate accepted, which is ___________
3. What is the bid-to-cover ratio? = Total $ Bid / Total $ Awarded = $200 mill. / $120 mill = ______
Copyright 2015 Diane Scott Docking 30
Solution: T-Note/Bond Auction4. What was the price paid by the winning bidders given a coupon
rate of 6%?
FV = $1,000Pmt = 1,000 x 6% = 60/2 = $30 semi-annualN = 5 yrs. X 2 = 10 yrs.ieff = 6.1%/2 = 3.05%
Therefore:PV = 995.745761 = __________per bond
Municipal Bond Market
Copyright 2015 Diane Scott Docking 31
Copyright 2015 Diane Scott Docking 32
Municipal Bonds Issued by local, county, and state governments Used to finance public interest projects Types
__________________________________________ issued by a municipality and secured by taxes
_________________________________________ issued by municipality and secured by future user charges
(e.g.: Sewer bonds) _______________________________________
public financing of private business. Tax-free municipal interest rate =
taxable interest rate x (1 - marginal tax rate)im = it (1-T)
NOT Default-Free
Copyright 2015 Diane Scott Docking 33
Example: Corporate vs. Muni-BondAn investor has the following choices: Aa rated corporate bond yielding 6% Aa rated muni-bond yielding 4%
1) If the investor has a marginal tax rate of 30%, which bond should he/she select? 2) Of 40%?
Copyright 2015 Diane Scott Docking 34
Example: Corporate vs. Muni-BondAnswer:
1) The after-tax rate on the corporate = 6%(1 - 0.3) = 4.2% > 4% on the muni bond;
ORThe pretax equivalent rate on the muni bond = 4%/(1 - 0.3) = 5.7% < 6% on the corporate
Select the _____________________bond!
2) The after-tax rate on the corporate = 6%(1 - 0.4) = 3.6% < 4% on the muni bond;
ORThe pretax equivalent rate on the muni bond = 4%/(1 - 0.4) = 6.7% > 6% on the corporate
Select the ______________________bond!
Municipal Bond Quote http://finance.yahoo.com/bond screener
http://screener.finance.yahoo.com/bonds.html
Type Issue Price Coupon(%) Maturity YTM(%)CurrentYield(%)
Fitch Ratings Callable
Muni ILLINOIS HSG DEV AUTH HSG BDS 104.38 5.000 1-Jul-2048 4.744 4.790 AA Yes
Muni ILLINOIS FIN AUTH REV REV BDS 111.59 5.000 1-Jul-2046 4.341 4.481 AA Yes
Muni ILLINOIS FIN AUTH REV REV BONDS 109.29 5.500 15-Aug-2043 0.000 5.032 Not Rated No
Muni ILLINOIS HSG DEV AUTH HSG DEV REV BDS
104.49 5.000 1-Jul-2042 4.716 4.785 AA Yes
Muni ILLINOIS FIN AUTH REV REV BDS 121.00 8.000 15-May-2040 6.369 6.612 Not Rated Yes
Muni ILLINOIS FIN AUTH REV REV BDS 102.15 4.500 15-May-2037 4.349 4.405 AA Yes
Muni ILLINOIS FIN AUTH REV REF GO BDS 103.94 5.500 15-May-2037 5.212 5.291 Not Rated Yes
Copyright 2015 Diane Scott Docking 35
As of July 24, 2015:
Municipal Bond Quote http://finance.yahoo.com/bond screener
Type Issue Price Coupon(%) Maturity YTM(%)CurrentYield(%)
Fitch Ratings Callable
Muni ILLINOIS FIN AUTH REV REV BDS 102.15 4.500 15-May-2037 4.349 4.405 AA Yes
Copyright 2015 Diane Scott Docking 36
As of July 24, 2015
ILLINOIS FIN AUTH REV REV BDS As of 24-Jul-2015
OVERVIEW
State: IllinoisPrice: 102.15Coupon (%): 4.500Maturity Date: 15-May-2037Yield to Maturity (%): 4.349Current Yield (%): 4.405Fitch Ratings: AACoupon Payment Frequency: Semi-AnnualFirst Coupon Date: 15-Nov-2007Callable: Yes
BOND PROFILE
Type: MunicipalInsured: YesAlternative Minimum Tax: No
OFFERING INFORMATION
Quantity Available: 5
Minimum Trade Qty: 5
Dated Date: 17-May-2007
Settlement Date: 4-Dec-2014
Origination date was May 17, 2007.A 30-year bond, since maturing May 15, 2037.
The Coupon interest paid Semi-annually
YTM above iscalculated from this date.See next slide.
Copyright 2015 Diane Scott Docking 37
Example: Municipal Bond Quote
Current purchase price to an investor is: (Price / 100) x Face = (102.15 / 100) x $1000 = $1,021.50
Current Yield = coupon / price = 4.500/102.15 = .044052863 = 4.405%
Settlement date is Dec. 4, 2014 (see previous slide):Yield% = YTM of 4.349% is computed as follows:
FV=1,000PV=1,021.50Pmt=(.045 x $1000) = $45/ 2 = $22.50 semi-annually N= 8,192 days /365 = 22.44383562 yrs. x 2 = 44.88767123therefore i=2.174503 x 2 = 4.349006% = 4.349% (good)
Type Issue Price Coupon(%) Maturity YTM(%)CurrentYield(%)
Fitch Ratings Callable
Muni ILLINOIS FIN AUTH REV REV BDS 102.15 4.500 15-May-2037 4.349 4.405 AA Yes
As of July 24, 2015::
Copyright 2015 Diane Scott Docking 38
The Bond Market
My name is Bond,
Corporate Bond.
Sample Corporate Bond
39Copyright 2015 Diane Scott Docking
Copyright 2015 Diane Scott Docking 40
Corporate Bonds Face value of $1,000 Usually pay interest semi-annually Most have maturities between 10-30 years
If less than 10 years, referred to as Corp. Notes Secured by Collateral
Assets – real and financial ______________ - unsecured bonds.
Banks may own corporate bonds BAA grade (investment grade) or better
Thin market
Copyright 2015 Diane Scott Docking 41
Example: Corporate Bond Quote http://finance.yahoo.com/bonds; http://reports.finance.yahoo.com/z1?is=citigroup; http://finra-markets.morningstar.com/BondCenter/Default.jsphttp://screener.finance.yahoo.com/bonds.html
Issuer Name Symbol Coupon Maturity Moody’s/S&P/Fitch
Price YTM(%) Current Yield (%)
Callable
Citigroup Inc C.ALY 4.500% Jan. 14,2022
Baa2/A-/A 111.05 2.777 4.052 No
Current purchase price to an investor is: (Price / 100) x Face = (111.05 / 100) x $1000 = $1,110.50
Current Yield = coupon / price = 4.500/111.05 = .0405223 = 4.052%
Settlement date is Dec. 4, 2014 (see next slide):Yield% = YTM of 2.777% is computed as follows:
FV=1000PV=1,110.50Pmt=(.045 x $1000) = $45/ 2 = $22.50 semi-annually
N= 2,596 days/365 = 7.112328767 yrs. x 2 = 14.22465753therefore i=1.388573639 x 2 = 2.77714728% = 2.777% (good)
As of Tuesday July 28, 2015:
Example: Corporate Bond Quote
Copyright 2015 Diane Scott Docking 42
The Coupon interest paid Semi-annually
Bond was originallyissued Nov. 1, 2011.
CITIGROUP INC As of 28-Jul-2015
OVERVIEW Price: 111.05
Coupon (%): 4.500
Maturity Date: 14-Jan-2022
Yield to Maturity (%): 2.777
Current Yield (%): 4.052
Fitch Ratings: A
Coupon Payment Frequency: Semi-Annual
First Coupon Date: 14-Jul-2012
Type: Corporate
Callable: No
OFFERING INFORMATION Quantity Available: 18
Minimum Trade Qty: 1
Dated Date: 1-Nov-2011
Settlement Date: 4-Dec-2014
YTM on previous slide isCalculated from this date.
Copyright 2015 Diane Scott Docking 43
Corporate Bond Terminology Indenture Trustee Sinking Fund Provision Protective/Restrictive Covenants Call provisions
Copyright 2015 Diane Scott Docking 44
Corporate Bonds - Types Junk bonds vs. Angel bonds Bearer bonds vs. Registered bonds Term bonds vs. Serial bonds Mortgage bonds Debentures and Subordinated debentures
Callable bonds vs. Putable bonds Convertible bonds vs. Stock Warrants Eurobonds
Eurodollar bonds
Copyright 2015 Diane Scott Docking 45
Example: Convertible BondsTitan Corp. has a convertible bond issue outstanding.
Each $1,000 face value of bond can be converted into common shares at a conversion rate 285.71. Titan’s common stock is currently trading at $9.375 per share. The bonds are trading at 267.875% of par.
1. What is the conversion price per share?
2. What is the conversion value of each bond?
3. Is it profitable for bond holders to convert their bonds to stock?
Copyright 2015 Diane Scott Docking 46
Solution to Example: Convertible BondsGiven: Bond price = $2,678.75 per $1,000 face.
Stock price = $9.375 / sh.
Conversion rate = 285.71
1. What is the conversion price per share?
$1,000 / 285.71 = ____________________
2. What is the conversion value of each bond?
CV = stock price x conv.rate = $9.375 x 285.71 = ___________
3. Is it profitable for bond holders to convert their bonds to stock? ______, CV Bond price
Corporate Bonds: Debt Ratings
47Copyright 2015 Diane Scott Docking
Copyright 2015 Diane Scott Docking 48
Foreign Bonds Foreign bonds
bonds issued in the national market by a nonresident borrower and denominated in the national currency.
bonds issued and sold in the U.S. by foreign firms and denominated in dollars
bonds issued and sold in Japan by foreign firms and denominated in yen
bonds issued and sold in the UK by foreign firms and denominated in British sterling pounds
Copyright 2015 Diane Scott Docking 49
Foreign Bonds
bonds issued and sold in Canada by foreign firms and denominated in Canadian dollars
bonds issued and sold in Australia by foreign firms and denominated in the Australian dollar
bonds issued and sold in an Asian nation (other than Japan or China) by foreign firms and denominated in that country’s currency
E.g.: bonds issued and sold in Malasia by foreign firms and denominated in Malaysian Ringgit
Copyright 2015 Diane Scott Docking 50
Foreign Bonds
bonds issued and sold in New Zealand by foreign firms and denominated in New Zealand dollars
bonds issued and sold in the Netherlands by
foreign firms and denominated in Euros
bonds issued and sold in Spain by foreign firms and denominated in Euros
bonds issued and sold in Korea by foreign
firms and denominated in wons
Copyright 2015 Diane Scott Docking 51
Foreign Bonds
bonds issued and sold in Turkey by foreign firms and denominated in the Turkish lira
bonds issued and sold in China by foreign
firms and denominated in yuans (aka: Renminbi (RMB))
bonds issued and sold in Tawain by foreign
firms and denominated in Taiwan Dollar
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