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  • 1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown Chapter 17
  • 2. Chapter 17 Bond Fundamentals
    • Questions to be answered:
    • What are some of the basic features of bonds that affect their risk, return, and value?
    • What is the current country structure of the world bond market and how has the makeup of the global bond market changed in recent years?
  • 3. Chapter 17 Bond Fundamentals
    • What are the major components of the world bond market and the international bond market?
    • What are bond ratings and what is their purpose?
    • What is the difference between investment-grade bonds and high-yield (junk) bonds?
  • 4. Chapter 17 Bond Fundamentals
    • What are the characteristics of bonds in the major bond categories such as governments (including TIPS), agencies, municipalities, and corporates?
    • How does the makeup of the bond market in major countries such as the United States, Japan, the United Kingdom, and Germany differ?
  • 5. Chapter 17 Bond Fundamentals
    • What are the important characteristics of corporate bond issues developed in the United States during the past decade such as mortgage-backed securities, other asset-backed securities, zero-coupon and deep discount bonds, high-yield bonds, and structured notes?
    • How do you read the quotes available for the alternative bond categories (e.g., governments, municipalities, corporates)?
  • 6. Basic Features of a Bond
    • Pay a fixed amount of interest periodically to the holder of record
    • Repay a fixed amount of principal at the date of maturity
  • 7. Basic Features of a Bond
    • Bond market is divided by maturity
      • Money Market - short-term issues that mature within one year
      • Notes - intermediate-term issues that mature between one and ten years
      • Bonds - long-term obligations with maturity greater than ten years
    • Remaining life (maturity) affect price volatility
  • 8. Bond Characteristics
    • Intrinsic features
      • Coupon - yield (interest income)
      • Maturity - term or serial (municipalities)
      • Principal value - different from market value
      • Type of ownership - bearer or registered
    • Types of Issues
      • Secured (senior) bonds
      • Unsecured bonds (debentures)
      • Subordinated (junior) debentures
  • 9. Bond Characteristics
    • Indenture provisions
    • Features affecting a bond’s maturity
      • Callable (call premium)
      • Noncallable
      • Deferred call
      • Nonrefunding provision
      • Sinking fund
  • 10. Rates of Return on Bonds
    • where:
    • HPR i,t = the holding period for bond i during the period t
    • P i,t+1 = the market price of bond i at the end of period t
    • P i,t = the market price of bond i at the beginning of period t
    • Int i,t = the interest payments on bond i during period t
    • The holding period yield (HPY) is:
    • HPY = HPR - 1
  • 11. The Global Bond-Market Structure
    • Participating issuers
      • 1. Federal governments
      • 2. Agencies of the federal government
      • 3. State and local political subdivisions (municipalities)
      • 4. Corporations
      • 5. International issues
        • Foreign bonds
        • Eurobonds
  • 12. Participating Investors
    • Individual investors
    • Institutional investors
      • Life Insurance Companies
      • Commercial Banks
      • Property and Liability Insurance Companies
      • Pension Funds
      • Mutual Funds
  • 13. Bond Ratings
    • Major Rating Agencies
    • Standard & Poor’s
    • Moody’s
    • Fitch Investor Services
  • 14. Alternative Bond Issues
    • Domestic government bonds
      • United States - T-bills, notes, bonds. TIPS
      • Japan - medium term, long term, super long term
      • Eurozone – government bonds
      • United Kingdom - short gilts, medium gilts, long gilts
  • 15. Government Agency Issues
    • United States
      • Not direct issues, but backed by “full faith and credit” of the U.S. government
      • GNMA pass-through certificates
    • Japan
      • Government associate organizations
    • United Kingdom
      • There are no agency bonds in the U.K.
    • Eurozone
      • Agency bonds are not broken down in the Eurozone
  • 16. Municipal Bonds
    • General obligation (GO) bonds
    • Revenue bonds
    • Interest payments are exempt from federal income tax
    • Convert the tax-free yield of a municipal bond selling close to par to an equivalent taxable yield (ETY)
  • 17. Equivalent Taxable Yield
    • Where:
    • i = coupon rate of the municipal obligations
    • T = marginal tax rate of the investor
  • 18. Municipal Bond Guarantees
    • Bond insured against default risk
      • Insurance is irrevocable for the life of the issue
    • Four private bond insurance carriers
      • Municipal Bond Investors Assurance (MBIA)
      • American Municipal Bond Assurance Corporation (AMBAC)
      • Financial Security Assurance
      • Financial Guaranty Insurance Company (FGIC)
  • 19. Municipal Bond Guarantees
    • Insured bonds obtain AAA (Aaa) ratings
    • Issues with private guarantees have more active secondary market, and lower required yield
  • 20. Corporate Bonds
    • Mortgage bonds
    • Collateral trust bonds
    • Equipment trust certificates
    • Collateralized mortgage obligations (CMOs)
    • Other asset-backed securities (ABS)
    • Variable rate notes
  • 21. Corporate Bonds
    • Zero-coupon and deep-discount bonds
      • Minicoupon bonds
      • Original-issue discount (OID) bonds
      • Taxes due on the implied interest
    • High-yield bonds (speculative bonds and junk bonds)
      • Noninvestment grade with rating below BBB or Baa
  • 22. Japanese Corporate Bond Market
    • Bonds issued by industrial firms or utilities
    • Minimum issuing requirements are specified by the Ministry of Finance
    • Bonds issued by banks to finance loans to corporation
      • Commercial banks
      • Long-term credit banks
      • Mutual loan and savings banks
      • Specialized financial institutions
  • 23. U.K. Corporate Bond Market
    • Debentures
    • Unsecured loans
    • Convertible bonds
  • 24. Eurozone Corporate Bond Market
    • Nonbank corporate bonds including industrial and utility firms
    • “Corporate-monetary Financial” including borrowing by banks
  • 25. International Bonds
    • Foreign bonds are sold in one country and currency by a borrower of a different nationality
      • Yankee bonds are U.S. dollar denominated bonds sold in the U.S. but issued by a foreign firm
    • Eurobonds are underwritten by international bond syndicates and sold in several national markets
  • 26. International Bonds
    • United States
      • Yankee bonds register with SEC
      • Eurodollar bond market affected by changes in value of U.S. dollar
  • 27. International Bonds
    • Japan
      • Samuri bonds - yen denominated issued by non-Japanese firms in Japan
      • Euroyen bonds - yen denominated, sold outside Japan
  • 28. International Bonds
    • United Kingdom
      • Bulldog bonds are sterling-denominated bonds issued by non-English firms and sold in London
      • Eurosterling bonds are sold in markets outside London by international syndicates
  • 29. International Bonds
    • Eurozone
      • Market popular among foreign issuers including issuers domiciled in the U.S.
      • Impressive growth in Eurobonds issued by non-residents
  • 30. Obtaining Information on Bonds
    • Less emphasis on fundamental analysis
    • Most bond investors rely on rating agencies for credit analysis
    • Market and economic conditions
    • Intrinsic bond features
    • Popular publications available:
      • Wall Street Journal, Barron’s, Business Week, Fortune, Forbes, Federal Reserve Bulletin, Survey of Current Business
  • 31. Bond Publications
    • Treasury Bulletin
    • Standard & Poor’s Bond Guide
    • Moody’s Bond Record
    • Moody’s Bond Survey
    • Fitch Rating Register
    • Fitch Corporate Credit Analysis
    • Fitch Municipal Credit Analysis
    • Investment Dealers Digest
    • Credit Markets
    • Duff & Phelps Credit Decisions
    • The Bond Player
  • 32. Sources of Bond Quotes
    • Bank and Quotation Record
    • The Blue List of Current Municipal Offerings
    • Wall Street Journal
    • Barron’s
  • 33. Interpreting Bond Quotes
    • Quoted on basis of yield or price
    • Price quotes are percentage of par
      • 98 1/2 is not $98.50 but 98.5% of par
      • A municipal $5,000 bond quoted at 98 1/2 would be $4,925
  • 34. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
  • 35. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • Issued by Ford Motor Company
  • 36. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • The maturity date of this bond
  • 37. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • The last transaction price was 80.625 percent of par or $806.25, which implies an yield to maturity (YTM) for this bond of 9.461 percent
  • 38. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • The computed yield spread for the Ford bond is 503 basis points (5.03 basis points)
  • 39. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • Comparable U.S. treasury Issue
  • 40. Corporate Bond Quotes
    • Company Last Last EST UST EST $
    • (Ticker) Price Yield Spread VOL
    • Ford 7.45 July 16 2031 80.625 9.461 503 30 213,645
    • The trading volume for this bond is over $213 million
  • 41. Treasury and Agency Bond Quotes
    • Notations
      • “n” = treasury note
      • “i” = inflation-indexed issue
      • “p” = treasury note on which nonresident aliens are exempt from withholding taxes on interest
    • Quotes resemble those used for OTC securities because they contain both bid and ask prices
  • 42. Treasury and Agency Bond Quotes
    • GOVT. BONDS & NOTES
    • Maturity Ask
    • Rate Mo/Yr Bid Asked Chg. Yld.
    • 5.750 Nov 05n 101:05 101:06 …. 3.13
  • 43. Treasury and Agency Bond Quotes
    • GOVT. BONDS & NOTES
    • Maturity Ask
    • Rate Mo/Yr Bid Asked Chg. Yld.
    • 5.750 Nov 05n 101:05 101:06 …. 3.13
    • This is a 5.75 percent obligation bond due in November 2005. The bid quote is 101:05, and the ask is 101:06
  • 44. Treasury and Agency Bond Quotes
    • U.S. Treasury Strips
      • “ci” is the coupon interest portion stripped from the note
      • “np” is the principal payment for the treasury note
    • Treasury Bills
      • Pure discount instrument - there is no coupon, they pay par at maturity
      • The bid-ask is not the price but the yield
  • 45. Municipal Bond Quotes
    • 200 INDIANA ST OFFICE BLDG COMMN MBIA 0.000 07/01/10 5.60 BEARSTER
    Quote from The Blue List of Current Municipal Offerings $200,000 of Indiana State Office Building bonds Guaranteed by MBIA These are zero coupon bonds due July 1, 2010 The yield to maturity is given as 5.6% To determine the price you compute the discount value The dealer offering the bonds is Bear Sterns, listed in the back of the publication with their phone number
  • 46. Municipal Bond Quotes
    • Notations
      • ETM = escrow till maturity
      • M/S/F = mandatory sinking fund
      • (C97) = this bond became callable in 1997
      • When the market yield equals the coupon rate, the price is 100 and they are referred to as dollar bonds
      • “+” in the left column indicates a new item
      • “#” before yield to maturity or price indicates a change
  • 47. The Internet Investments Online
    • http://www.bondheads.com
    • http://www.investinginbonds.com
    • http://www.fitch.com
    • http://www.moodys.com
    • http://www.standardandpoors.com/ratings
    • http://www.bradynet.com
    • http://www.publicdebt.treas.gov
  • 48.
    • End of Chapter 17
      • Bond Fundamentals
  • 49. Future topics Chapter 18
    • The Analysis and Valuation of Bonds

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