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					Chapter 7: Bond Markets
         Chapter 7: Bond Markets

Chapter Outline:
•   Introduction to Bonds.
•   Treasury and Federal Agency Bonds.
•   Municipal Bonds.
•   Corporate Bonds.
•   Institutional Use of Bond Markets.
•   Globalization of Bond Markets.

          Introduction to Bonds:

• A bond is a long-term debt security.
• The bond is issued by the borrower (i.e. the
  issuer) who promises to make payments of
  interest and principal, on specific dates, to the
  lenders (i.e. the bondholders).
      Introduction to Bonds:

Who issues bonds?
• The U.S. federal government
• State and local governments
• Corporations
• Foreign governments or corporations
   Valuation: Determining the
        Intrinsic Value

• Intrinsic Value: the present value of the
  future cash flows provided by the security.

          CF1        CF2            CFn
Value = (1 + k)1 + (1 + k)2 . . . (1 + k)n
  Key Characteristics of Bonds

• Par value: face amount; paid at maturity.
  Normally in denominations of $1,000.
• Coupon interest rate: stated annual interest
  rate on a bond. Multiply by par value to get
  the annual interest payment (coupon
  payment). Most bonds have fixed coupon
       Special Types of Bonds

• Zero coupon bond: a bond that pays no
  annual interest; it provides compensation to
  investors in the form of capital appreciation.
• Floating rate bond: a bond whose coupon
  rate fluctuates with shifts in the general
  level of interest rates.
  Key Characteristics of Bonds

• Maturity date: a specified date on which the
  par value is repaid.
• Term to maturity: the length of time until
  maturity date.
• Payment pattern: the frequency of the
  interest payments. Most bonds in the U.S.
  pay interest semiannually.
  Key Characteristics of Bonds

• Bond ratings: ratings on corporate bonds
  that provide an indication of default risk.
• Current yield: the ratio of the annual
  interest payment to the bond’s market price.

• Yield to maturity (YTM) is the rate of
  return earned on a bond held to maturity.
• It is the discount rate that equates the
  present value of the future cash flows with
  the current market price of the bond.
• Represents investor’s total return from settlement day until
  security expiration
• Allows investors to compare bonds with different
  maturities and coupon rates via internal rate of return
• Bond yields inversely related to bond prices

 Common maturities:
   short term: up to five years
   medium term: 5-12 years
   long term: 12 or more years
  Treasury and Federal Agency Bonds:

• Treasury Bond Auction.
• Trading Treasury Bonds.
• Treasury Bond Quotations.
• Stripped Treasury Bonds.
• Inflation-Indexed Treasury Bonds.
• Savings Bonds.
• Federal Agency Bonds.
             Municipal Bonds:

• Credit Risk.
• Characteristics of Municipal Bonds.
• Trading and Quotations.
• Yields offered on Municipal Bonds.
• Yield Curve on Municipal Bonds.
                Corporate Bonds:

• Definition.
• Maturities.
• Yield Curve.
• Default Rate.
• Assessment of Risk.
• Bond Ratings.
• Private Placement of Corporate Bonds.
              Corporate Bonds:

Characteristics of Corporate Bonds:
•   Sinking-Fund Provision.
•   Protective Covenants.
•   Call Provisions.
•   Bond Collateral.
•   Low and Zero Coupon Bonds.
•   Variable Rate Bonds.
•   Convertibility.
             Corporate Bonds:

• Trading Corporate Bonds.
• Types of orders:
     Market Order.
     Limit Order.
• Trading online.
• Corporate Bond Quotations.
                Junk Bonds:

• Definition.
• Junk Bonds Market.
• Participation in the Junk Bonds Market.
• Risk Premium of the Junk Bonds.
• Performance of Junk Bonds.
• Contagion Effects in the Junk Bond Market.
            Corporate Bonds:

• Using Bonds to Finance a Leveraged Buyout
• Using Bonds to Revise the Capital Structure.
  – Debt for equity swap.
  – Equity for debt swap.
   Institutional Use of Bond Markets:

• See Page 178.
   Globalization of Bonds Markets:

• Introduction.
• Eurobond Market.
• Government Bonds (Sovereign Bonds).
• Global Junk Bonds.
End of Chapter 7

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