1. What is a bond?A bond is simply a loan, but in the form of a
security. The issuer of the bond is the borrower and investors
(bondholders) are the lenders.are used to finance a firms (usually
long-term) investments. Bonds Bank loans tend to involve shorter
term lending periods.
2. Primary market: where new bonds are issued to investors.
Secondary market: where previously issued bonds trade. Most
secondary market trading occurs in a decentralized (fragmented) OTC
marketin part because no two bonds are alike.Size of bond market:
Face value of all bonds outstanding worldwide in 2007 was about $65
Trillion. Contrast this with the equities where global
capitalization was about $55 Trillion. 3. Yum! Brands$350,000,000
face value 3.875% coupon 3.89% yield/99.867price Citigroup, Goldman
and JPM/Chase lead 10 year bonds maturing November 1st 2020 US 10
yearBonds Issued 8/16 $24 billion 2.625% coupon 2.730% yield 4.
TreasurySector: debt issued by US government: Treasury bills,
notes, and bonds. US government is largest issuer of securities in
th eworld. AgencySector: securities issued by government-sponsored
organizations. Municipal Sector: debt issued by state and local
governments Also called the taxexempt sector. 5. CorporateSector:
debt issued by corporations (also called credit sector): Commercial
paper, notes, bonds. Subsectors: investment grade and
noninvestmentgrade sectors.Sector issuer pools loans and
receivables as collateral for the issuance of securities.
Mortgage-backed Sector debt backed by pool of mortgage loans:
Asset-backed Subsectors: Residential mortgage sector andCommercial
mortgage sector. 6. Bondfeatures are outlined in a contract between
the issuer and investors (called the indenture): Term to maturity
Principal amount Coupon rate Amortization features Embedded
options. 7. Termto maturity: # of years until the bond expires.
Usually just called term or maturity.Bond terms: Short term: 1 to 5
years. Intermediate term: 5 to 12 years. Long term: > 12 years.
8. Principal:The amount the issuer agrees to repay to bondholders
at the maturity date. Also commonly called: face value, par value,
maturityvalue. CouponRate: the annual interest rate the issuer
agrees to pay on the face value (principal). The coupon is the
annual amount the issuer promisesto pay (in $): coupon = coupon
rate *principal The coupon is paid semiannually on most bonds. 9.
Somebonds pay no coupons (zerocoupon bonds). Zeros are sold at a
substantial discount to face value and redeemed at face value at
expiration. All interest is therefore received at expiration. Some
bonds have floating coupons The coupon resets periodically,
according to some formula 10. Thecoupon for a floater is determined
by the following general formula: Floater coupon = floating
reference rate + fixedmargin 11. The principal on a bond can be
paid two ways: Paid all at once at expiration (bullet maturity).
Paid little-by-little over the life of the bondaccording to a
schedule (amortizing). Oneadvantage of a bond that amortizes
principal is that the issuer wont have to fund a big balloon
payment at expiration. 12. Optionsare actions that can be taken by
either the issuer or the investor. Themost common is a call
provision: Grants issuer the right to retire bonds (fully or
partially) prior to maturity. Putprovision: Enables the bondholder
to sell the issue back to issuer at par value prior to expiration.
13. bond gives bondholders the right to exchange the bond for a
specified number of shares of common stock. Convertible This is
advantageous to investors if firms stockprice goes up.bond allows
bondholders to exchange the bond for a specified number of shares
of common stock of another firm. Exchangeable 14.
Interest-rateRisks - Associated with Bond Investing , thereby
reducing a bonds price (also called market risk). The major risk
faced by bond investors.risk the risk that the interest rate at
which intermediate cash flows can be reinvested will fall.
Reinvestmentrisk the risk the issuer may call or retire all or part
of the issue before the maturity date. Call 15. risk risk that
issuer will fail to satisfy the terms of the bond. CreditDefault
risk: Risk the issuer does not repay part or all of its financial
obligation. 2. Credit spread risk: Risk that an issuers obligation
will decline due to an increase in the credit spread (the part of
the risk premium or yield spread attributable to default risk). 3.
Credit deterioration risk: Risk that the credit quality of the
issuer decreases (closely related to credit spread risk). 1. 16.
risk the risk that the purchasing power of a bonds cash flows may
decline. Inflation Floating rate bonds have a lower level of
inflationrisk than coupon bonds.rate risk if a bond is denominated
in a foreign currency (e.g., the euro), the value of the cash flows
in US$ will be uncertain. Exchange 17. risk the risk that the bond
cannot be sold with ease at (or near) its current value. Liquidity
Unimportant for investors holding a bond tomaturity. Liquidity can
be measured by the bid-ask spread. The wider the spread the less
liquid a bond is. Sometimes called marketability risk. 18. risk the
value of embedded options is determined partly by the volatility of
interest rates Volatility The price of a bond with embedded options
willchange as interest rate volatility changes.risk The bond market
has been a hotbed of financial innovation. Risk The risk/return
characteristics of innovative securitiesare not always understood.
Risk risk is not knowing what the risk of a security is. 19. THANK
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