3. Definition
A bond is a borrowing
arrangement through which
the borrower (or seller of a
bond) issues or sells an IOU
document to the investor
(or buyer of the bond).
Debt Securities with Fixed
Income.
4. Why Issue Debt
Firm wants to raise capital
Does not want to dilute
ownership
Can earn more money on the
use of the funds in the business
than the cost of interest on the
debt.
5. TERM
The length of time until the principal
amount of a bond must be repaid.
Maturity Date: The end of the life of a
security. The day on which the principal
or amount must be repaid.
Face/Par value
What the Bond reads and what the
investor receives if they hold the bond to
its maturity.
Face Value of most treasuries is $1000.
6. Why invest in a bond?
To distribute risk across a
diversity of investments
holdings.
Investors want a steady reliable
interest payment and return of
their full capital or investment at
the end of the term of the bond
7. KEY TERMS
Coupon Payments: amount
of interest paid, usually 2
times a year.
Price of Bond: The amount
someone will pay for that
bond in the open market.
8. Ratings – Bond Risk
An evaluation of the possibility of default by a
bond issuer. It is based on an analysis of the
issuer's financial condition and profit potential.
Bond rating services are provided by, among
others, Standard & Poor's, Moody's Investors
Service, and Fitch Investors Service.
Bond ratings start at AAA (being the highest
investment quality) and usually end at D (in
payment default).
9. Types of Bonds
Municipal
Treasuries
Zero-Coupon
Junk / Speculative-grade
International
10. Innovation in Bond Market!
Issuers constantly develop innovative
bonds with unusual features,
displaying the flexibility of bond
design
13. Valuation of a Bond- Terms
There are many factors that influence
Bond pricing: Interest or coupon rate;
Ratings of a Company’s ability or
certainty to make repayment, time to
maturity.
But fundamentally, valuation depends on
the interest rate on the face of the bond
in comparison to the interest rate for a
comparable bond just being issued
14. Example of Valuation of Bonds
Take a U.S. Treasury bond with a $1,000.
face value. The question is its value
today- what would you pay for it now??
First look at its due date: It was issued on
March 1, 1999 and will mature (come
due) in 30 years. Next look at its coupon.
The coupon or interest rate payable on the
bond as of the date of issue is 8% per
annum paid ½ on Sept 1 and ½ March 1
Thus , twice a year you receive 40.00
Now compare this to a new bond offering:
15. Bond valuation
New Bond of 1,000.00 just issued is due in
2029 or 25 years.
It’s coupon or interest rate is 4%
You get $20.00 two times a year or $40.
Since the term is still fairly far off, the value of
the older bond will be priced for the most part
based on its yield or coupon in relation to what
can be had today less a discount of its face
value.
The old bond yields 80.00 per year or twice as
much as this bond. Therefore its value is twice
as much since you would have to buy 2,000.00
worth of bonds now to get the same return.
16. Formula
Face Value of Old Bond: 8% of $1,000 =
$80.00 per annum
New Bond: 4% of 1,000.00= 40.00
.04 X = 80.00
X = 2,000.00
Value of old bond today is 2000.
When interest rates rise the value of the
bond goes down.
Value of bonds move in the opposite
direction of interest rates.
