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BondsPresentation
- 1. Bonds basics Bank of America Presented by: Alina Tsyba June 13, 2016
- 2. 2 Agenda • Bond concepts • Bond pricing • Key characteristics • Key Risk • Types of bonds - By coupon type - By maturity date - By repayment schedule - By bond feature • Conclusion • Questions
- 3. 3 Bond concepts A Bond is a way of raising public funds in which an investor loans money to an entity for a defined period of time at a variable or fixed interest rate. Coupon • Is the interest rate stated on bond when it is issued • Typically paid semi-annually Maturity • The date at which the borrower has to pay back to the lender the full amount of the outstanding principal and any applicable interest
- 4. 4 Bond pricing • Sold at premium • Interest rates offered in the market are lower than coupon rate • Credit rating of the bond is increased • Demand exceeds supply Above par Below par • Sold at discount • Interest rates offered in the market are higher than coupon rate • Credit rating of the bond is lowered • Supply exceeds demand As time approaches maturity date, the price converges to par. 90 95 100 105 110 115 120 125 130 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 Price Months
- 5. Issuer Priority Coupon rate Features • Corporation • Government • Fixed • Floating • Zero • Callable • Puttable • Convertible • Unsubordinated • Subordinated 5 Characteristics Key Characteristics
- 6. 6 Risks Interest rates Issuer riskCredit risk Inflation risk • Price affected by interest rate moves • Risk of default • Risk that inflation exceeds the return rate • Issuer rating change • Governed by rating agency • Event risk Key Risks Liquidity • Bond may be difficult to trade
- 7. 7 Types of bonds - by coupon types Coupon Fixed rate coupon • Pays the same amount of interest throughout lifetime of bond Zero coupon • No coupon received during lifetime of bond • Only payment at maturity date • Traded below par • Useful when specific income is needed at a specific point of time in the future • Easy to handle, does not require much attention Floating coupon • Recalculated periodically with a reference to an interest rate index such as LIBOR
- 8. 8 Types of bonds - by maturity date Bills < 1 year 10 years < Bonds 1 year < notes < 10 years Consol – no maturity date
- 9. 9 Types of bonds - by repayment schedule Bond Coupon payments are made periodically over the term of the bond Bullet Bond Pays fixed rate interest and principal at a single maturity date Has higher credit risk Sensitive to rate fluctuations Amortized Bond Repays part of the principal along with the coupon payments Have a lower credit risk Less sensitive to interest rate fluctuations Sinking Bond Issuer puts aside some money to retire bond before maturity Less likely to default Likely to be repaid before maturity
- 10. 10 Types of bonds – by bond feature • Can be bought back by issuer during defined period of time at option of bond issuer • Additional “call risk” Callable • Can be converted into stock • Usually has lower coupon rate as offers flexibility • Can be a good opportunity to buy stock at a price lower than market price Convertible • Can be sold back from to issuer at defined period of time at option of bond holder • Additional flexibility to the investor Puttable
- 11. 11 Conclusion Lowest risk • Convertible • Puttable • Amortized • Floating rate coupon • Short term • Government issued • Good credit rating Highest risk • Zero coupon • Long term • Callable • Low credit rating • Defined bond and main characteristics • Looked at different types of bonds • Analysed associated risks
- 12. Questions?