Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown Chapter 18

Chapter 18 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?

Chapter 18 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?

Chapter 18 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?

Chapter 18 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?

Chapter 18 Bond Fundamentals Within each of the major bond categories, what are the differences between major countries such as the United States, Japan, the United Kingdom, and Germany How do you read the quotes available for the alternative bond categories (e.g., governments, municipalities, corporates)?

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

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

Bond Characteristics Indenture provisions Features affecting a bond’s maturity –Callable (call premium) –Noncallable –Deferred call –Nonrefunding provision –Sinking fund

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

Corporate Bonds Mortgage bonds Collateral trust bonds Equipment trust certificates Collateralized mortgage obligations (CMOs) Other asset-backed securities (ABS) Variable rate notes

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