1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown
Chapter 17

2. Chapter 17 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?

3. Chapter 17 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?

4. Chapter 17 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?

5. Chapter 17 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?
How do you read the quotes available for the alternative bond categories (e.g., governments, municipalities, corporates)?

6. 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

7. 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

8. Bond Characteristics Intrinsic features Types of Issues
Coupon - yield (interest income)
Maturity - term or serial (municipalities)
Principal value - different from market value
Type of ownership - bearer or registered
Types of Issues
Secured (senior) bonds
Unsecured bonds (debentures)
Subordinated (junior) debentures

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

10. Rates of Return on Bonds
where:
HPRi,t = the holding period for bond i during the period t
Pi,t+1 = the market price of bond i at the end of period t
Pi,t = the market price of bond i at the beginning of period t
Inti,t = the interest payments on bond i during period t
The holding period yield (HPY) is:
HPY = HPR - 1

11. The Global Bond-Market Structure
Participating issuers
1. Federal governments
2. Agencies of the federal government
3. State and local political subdivisions (municipalities)
4. Corporations
5. International issues
Foreign bonds
Eurobonds

12. Participating Investors
Individual investors
Institutional investors
Life Insurance Companies
Commercial Banks
Property and Liability Insurance Companies
Pension Funds
Mutual Funds

13. Bond Ratings Major Rating Agencies Standard & Poor’s Moody’s
Fitch Investor Services

14. Alternative Bond Issues
Domestic government bonds
United States - T-bills, notes, bonds. TIPS
Japan - medium term, long term, super long term
Eurozone – government bonds
United Kingdom - short gilts, medium gilts, long gilts

15. Government Agency Issues
United States
Not direct issues, but backed by “full faith and credit” of the U.S. government
GNMA pass-through certificates
Japan
Government associate organizations
United Kingdom
There are no agency bonds in the U.K.
Eurozone
Agency bonds are not broken down in the Eurozone

16. Municipal Bonds General obligation (GO) bonds Revenue bonds
Interest payments are exempt from federal income tax
Convert the tax-free yield of a municipal bond selling close to par to an equivalent taxable yield (ETY)

17. Equivalent Taxable Yield
Where:
i = coupon rate of the municipal obligations
T = marginal tax rate of the investor

18. Municipal Bond Guarantees
Bond insured against default risk
Insurance is irrevocable for the life of the issue
Four private bond insurance carriers
Municipal Bond Investors Assurance (MBIA)
American Municipal Bond Assurance Corporation (AMBAC)
Financial Security Assurance
Financial Guaranty Insurance Company (FGIC)

19. Municipal Bond Guarantees
Insured bonds obtain AAA (Aaa) ratings
Issues with private guarantees have more active secondary market, and lower required yield

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

21. 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

22. Japanese Corporate Bond Market
Bonds issued by industrial firms or utilities
Minimum issuing requirements are specified by the Ministry of Finance
Bonds issued by banks to finance loans to corporation
Commercial banks
Long-term credit banks
Mutual loan and savings banks
Specialized financial institutions

23. U.K. Corporate Bond Market
Debentures
Unsecured loans
Convertible bonds

24. Eurozone Corporate Bond Market
Nonbank corporate bonds including industrial and utility firms
“Corporate-monetary Financial” including borrowing by banks

25. International Bonds
Foreign bonds are sold in one country and currency by a borrower of a different nationality
Yankee bonds are U.S. dollar denominated bonds sold in the U.S. but issued by a foreign firm
Eurobonds are underwritten by international bond syndicates and sold in several national markets

26. International Bonds United States Yankee bonds register with SEC
Eurodollar bond market affected by changes in value of U.S. dollar

27. International Bonds Japan
Samuri bonds - yen denominated issued by non-Japanese firms in Japan
Euroyen bonds - yen denominated, sold outside Japan

28. International Bonds United Kingdom
Bulldog bonds are sterling-denominated bonds issued by non-English firms and sold in London
Eurosterling bonds are sold in markets outside London by international syndicates

29. International Bonds Eurozone
Market popular among foreign issuers including issuers domiciled in the U.S.
Impressive growth in Eurobonds issued by non-residents

30. Obtaining Information on Bonds
Less emphasis on fundamental analysis
Most bond investors rely on rating agencies for credit analysis
Market and economic conditions
Intrinsic bond features
Popular publications available:
Wall Street Journal, Barron’s, Business Week, Fortune, Forbes, Federal Reserve Bulletin, Survey of Current Business

31. Bond Publications Treasury Bulletin Standard & Poor’s Bond Guide
Moody’s Bond Record
Moody’s Bond Survey
Fitch Rating Register
Fitch Corporate Credit Analysis
Fitch Municipal Credit Analysis
Investment Dealers Digest
Credit Markets
Duff & Phelps Credit Decisions
The Bond Player

32. Sources of Bond Quotes Bank and Quotation Record
The Blue List of Current Municipal Offerings
Wall Street Journal
Barron’s

33. Interpreting Bond Quotes
Quoted on basis of yield or price
Price quotes are percentage of par
98 1/2 is not $98.50 but 98.5% of par
A municipal $5,000 bond quoted at 98 1/2 would be $4,925

34. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645

35. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
Issued by Ford Motor Company

36. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
The maturity date of this bond

37. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
The last transaction price was percent of par or $806.25, which implies an yield to maturity (YTM) for this bond of percent

38. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
The computed yield spread for the Ford bond is 503 basis points (5.03 basis points)

39. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
Comparable U.S. treasury Issue

40. Corporate Bond Quotes
Company Last Last EST UST EST $
(Ticker) Price Yield Spread VOL
Ford July ,645
The trading volume for this bond is over $213 million

41. Treasury and Agency Bond Quotes
Notations
“n” = treasury note
“i” = inflation-indexed issue
“p” = treasury note on which nonresident aliens are exempt from withholding taxes on interest
Quotes resemble those used for OTC securities because they contain both bid and ask prices

42. Treasury and Agency Bond Quotes
GOVT. BONDS & NOTES
Maturity Ask
Rate Mo/Yr Bid Asked Chg Yld.
Nov 05n 101: : …

43. Treasury and Agency Bond Quotes
GOVT. BONDS & NOTES
Maturity Ask
Rate Mo/Yr Bid Asked Chg Yld.
Nov 05n 101: : …
This is a 5.75 percent obligation bond due in November The bid quote is 101:05, and the ask is 101:06

44. Treasury and Agency Bond Quotes
U.S. Treasury Strips
“ci” is the coupon interest portion stripped from the note
“np” is the principal payment for the treasury note
Treasury Bills
Pure discount instrument - there is no coupon, they pay par at maturity
The bid-ask is not the price but the yield

45. Municipal Bond Quotes
200 INDIANA ST OFFICE BLDG COMMN MBIA /01/ BEARSTER
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. Municipal Bond Quotes Notations ETM = escrow till maturity
M/S/F = mandatory sinking fund
(C97) = this bond became callable in 1997
When the market yield equals the coupon rate, the price is 100 and they are referred to as dollar bonds
“+” in the left column indicates a new item
“#” before yield to maturity or price indicates a change

47. The Internet Investments Online

48. End of Chapter 17
Bond Fundamentals

49. Future topics Chapter 18
The Analysis and Valuation of Bonds