1 Bond : The Basics by Binam Ghimire

Learning Objectives  Understand the meaning and terminologies in bond  Understand types and feature of bond  Bond Ratings 2

Previous Knowledge 3

Fixed Income Securities  Pure-discount security  Coupon Security 4

Fixed Income Securities  Personal Savings – in a Commercial Bank: Demand Deposits, time-deposits, Certificates of deposits and Jumbos  Money Market Instruments: Commercial Paper, CDs, Bankers’ Acceptances, Eurodollars, Repurchase Agreements  Bond 5

Bond: What is it?  IOU  Long term fund requirement: issue bonds  Bond meaning: IOU certificate in which a company promise to make a series of fixed interest payments and in the end repay the debt 6

Bond: What is it?  From Paper to Electronic recording 7

8

9

Bond: Terminologies  Price = ? Yield = ?  Coupon = ?  The price of the bond is ……….. per …………..  Therefore to buy ……………….. face value of this bond would cost ……………..  You would receive ……………….. per annum per €100 of bond held  A holder of €1000 bond would receive ……………….. on the 4th Sept. each year 10

Bond: Terminologies  10Y Benchmark Bund 1.5% 4/9/22 Price = , Yield = 1.372%  A 10 year German Government AAA rated debt security, offering a 1.5% fixed coupon (paid once per year)  The price of the bond is € per €100  Therefore to buy €1000 face value of this bond would cost €  Coupon -You would receive €100 x 1.5% per annum per €100 of bond held  A holder of €1000 bond would receive €15 on the 4th Sept. each year 11

Bond: Terminologies  Yield to Maturity (YTM)  YTM is the interest rate that makes the present value of a bond’s payments equal to its price.  The YTM incorporates both the coupon return plus any capital gain or loss from holding the bond to maturity (…………….%)  Redemption Value and Maturity date  100% face value repaid on ………………..  Basis  Day count convention is …………………/……………… 12

Bond: Terminologies  Yield to Maturity (YTM)  The YTM incorporates both the coupon return plus any capital gain or loss from holding the bond to maturity (1.372%)  Redemption Value and Maturity date  100% face value repaid on 4th September 2022  Basis  Day count convention is Actual/Actual 13

Bond: Conventions 14  See excel file

Bond: Types (Issuers)  Treasury Bond: Government  Corporate Bond: Companies  Municipal Bond: State or local government  Foreign Bond: Foreign government/ companies 15

Bond: Types (Cash Flows)  Pure Discount Bonds  Level Coupon Bonds  Consols 16

Bonds Types (Nature) 17  Redeemable  Irredeemable  Convertible  Non-convertible  Extendable/ Retractable  Zero coupon/ Strip  Junk/ high yield/ non investment grade  Eurobonds  Inflation linked  Puttable  Floating  Preferred stock  ….

Bonds Types (Innovations) 18  Inverse Floaters  Asset-Backed Bonds  Catastrophe Bonds  Indexed Bonds

Bonds more … 19  The indenture  Call provisions  Sinking Funds  Private Placements  Bankruptcy, Distressed Securities

20 Bond Ratings  Bonds of the same maturity offer a different rate of return  Why ?  Due to the risk of default  The difference between the return on “safe” bonds (i.e. government) and “risky” bonds is called a default premium  How do you assess risk ?  Moodys and S&P - evidence suggest that low ranked bonds promise higher returns

21 Bond Ratings  Since the primary function of bonds as an investment vehicle is to make fixed payments, it's essential that the company or government issuing the debt has the ability to make all payments on time and in full. Bond ratings evaluate the debt issuer to determine the risk of default  The leading rating agencies, Standard & Poor's and Moody's Investors Services, assign ratings when a bond is first issued, and that rating helps determine how high the bond's interest rate will be. If the agencies assign a high rating, that means there's little risk of default, so the issuer can obtain a lower interest rate  While the rating systems of Moody's and S&P differ somewhat, they're more alike than different. Both agencies have investment-grade ratings, which connote a high level of creditworthiness, and speculative ratings, which mean higher risk levels and merit higher interest rates  Here are Moody's ratings, from highest to lowest. Investment grade: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3. Speculative grade: Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C1  Here are S&P's ratings. Investment grade: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-. Speculative grade: BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, D

Thank you 22