17

1,153 views

Published on

0 Comments
2 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
1,153
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
51
Comments
0
Likes
2
Embeds 0
No embeds

No notes for slide

17

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

×