C11_Reilly1ce

Investment Analysis and Portfolio ManagementFirst Canadian EditionBy Reilly, Brown, Hedges, Chang11

Copyright 2010 by Nelson Education Ltd. 11-*

Basic Features of a BondGlobal Bond Market StructureTypes of Bond IssuesObtaining Information on Bond Prices

Chapter 11 Bond Fundamentals


The Basic Features of a BondBonds as fixed income securitiesPay a fixed amount of interest periodically to the holder of recordRepay a fixed amount of principal at the date of maturity


The Basic Features of a BondBond market is divided by maturityMoney Market: Short-term issues that mature within one yearNotes: Intermediate-term issues that mature between one and ten yearsBonds: Long-term obligations with maturity greater than ten years


Bond CharacteristicsIntrinsic FeaturesCoupon: Determine the periodic interest incomeTerm to maturity: Term bond or a serial bond Principal value: Different from market value and the common principal or par value is $1,000Type of ownership: Bearer vs. registered bonds


Bond CharacteristicsTypes of IssuesSecured (senior) bondsUnsecured bonds (debentures)Subordinated (junior) debentures


Bond CharacteristicsIndenture provisionsThe indenture is the contract between the issuer and the bondholder specifying the issuers legal requirementsFeatures affecting a bonds maturityCallable (call premium)NoncallableDeferred callNonrefunding provisionSinking fund


Rates of Return on Bonds

where:HPRi,t = the holding period return for bond i during period tPi,t+1 = the market price of bond i at the end of period tPi,t = the market price of bond i at the beginning of period tInti,t = the interest payments on bond i during period t

Holding Period Return


Rates of Return on Bonds

Holding Period Yield


The Global Bond Market StructureThe market for fixed-income securities is substantially larger than the listed equity exchanges (NYSE, TSE, LSE) because corporations tend to issue bonds rather than common stockIn 2007, 30% of new security issues in Canada were equity (common and preferred)


The Global Bond Market StructureBond RatingsMost corporate and municipal bonds are rated by one or more of the rating agenciesThe exceptions are very small issues and bonds from certain industries, such as bank issues. These are known as non-rated bondsTwo major rating agenciesDominion Bond Rating Service (DBRS)Standard and Poors Rating Direct Canada


The Global Bond Market Structure: Bond Ratings


Types of Bond IssuesDomestic Government BondsCanadaT-bills, notes, bondsReal Return Bonds (RRBs)CPI indexed bondsCanada Savings Bonds (CSBs)JapanMedium term, long term, super long termUnited KingdomShort gilts, medium gilts, long giltsEurozoneGovernment bonds


Types of Bond IssuesGovernment Agency IssuesUnited StatesNot direct issues, but backed by full faith and credit of the U.S. governmentGNMA pass-through certificatesJapanAccount for about 7% of the total Japanese yen bond market


Types of Bond IssuesMunicipal Bonds General obligation (GO) bondsRevenue bondsInterest payments are exempt from federal income taxConvert the tax-free yield of a municipal bond selling close to par to an equivalent taxable yield (ETY)

where: i = coupon rate of the municipal obligations T = marginal tax rate of the investor


Types of Bond IssuesMunicipal Bond InsuranceSignificant feature of U.S. municipal bond market is municipal bond insuranceBond insured against default riskInsurance is irrevocable for the life of the issue


Types of Bond IssuesCorporate BondsMortgage bondsEquipment trust certificatesCollateral Trust BondsCollateralized mortgage obligations (CMOs)Asset-backed securities (ABSs)Certificates for automobile receivables (CARs)Credit card receivablesVariable rate notesZero coupon and deep discount bondsHigh-yield bonds


High-Yield BondsAlso known as speculative bonds and junk bondsBased on specification that bonds rated below BBB make up high-yield market, that is, non-investment grade bondsHigh-yield bond market exploded in size and activity beginning in the early 1980s Major owners of high-yield bonds have been mutual funds, insurance companies, and pension funds

Corporate Bonds


Japanese Corporate Bond MarketBonds issued by industrial firms or utilitiesMinimum issuing requirements are specified by the Ministry of FinanceBonds issued by banks to finance loans to corporationCommercial banksLong-term credit banksMutual loan and savings banksSpecialized financial institutions

Corporate Bonds


Pound Sterling Corporate Bond MarketThree FormsDebenturesUnsecured loansConvertible bondsMaturity structure is fairly wide Coupon structure is also broad with high-coupon bonds in the 10 to 14% rangeAlmost all U.K. corporate bonds are callable term bonds

Corporate Bonds


Eurozone Corporate BondsPure corporate bonds that include industrial and utility firms (about 15%) Securitized/collaterlized bonds that include indirect corporate borrowing (about 12%)

Corporate Bonds


Foreign bonds are sold in one country and currency by a borrower of a different nationalityFor example, Canadian dollar-denominated bonds sold in Canada by a Japanese firm (Maple bonds)Eurobonds are securities denominated in U.S. dollars and underwritten by international bond syndicates and sold to investors outside the U.S.

International Bonds


United StatesYankee bonds register with SECEurodollar bond market affected by changes in value of U.S. dollarJapanSamurai bonds: Yen denominated issued by non-Japanese firms in JapanEuroyen bonds: Yen denominated, sold outside Japan

International Bonds


United KingdomBulldog bonds are sterling-denominated bonds issued by non-English firms and sold in LondonEurosterling bonds are sold in markets outside London by international syndicatesEurozoneMarket popular among foreign issuers including issuers domiciled in the U.S.Impressive growth in Eurobonds issued by non-residents

International Bonds


Obtaining Information on BondsLess emphasis on fundamental analysisMost bond investors rely on rating agencies for credit analysisMarket and economic conditionsIntrinsic bond featuresNational Association of Securities Dealers (NASD) through Trade Reporting and Compliance Engine (TRACE)Release more timely information


Interpreting Bond Quotes


Interpreting Bond Quotes407 International Inc.6.05% couponPaid semi-annuallyMaturity July 27 09Last Price traded $101.76Yield, based on last price, is 3.82%

Copyright 2010 Nelson*Copyright 2010 Nelson

*Copyright 2010 Nelson




**Copyright 2010 Nelson



**Copyright 2010 Nelson

******Copyright 2010 Nelson










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