Investment Analysis & Portfolio Management Chapter 17 - Bond Fundamentals

Explain Muni Bond Quote of: 200 INDIANA ST OFFICE BLDG COMM MBIA 0.000 07/01/20 5.60 JP MOR CHASE

-$200,000 of Indiana State Office Building bonds -Guaranteed by MBIA -These are zero coupon bonds due July 1, 2020 -The yield to maturity is given as 5.6% -To determine the price you compute the discount value -Remember that the 5.6% YTM is a semi-annual rate -The dealer offering the bonds is JP Morgan -Chase, listed in the back of the publication with their phone number

International Bonds By Country - 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

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)

Corporate Bonds

-Mortgage bonds -Collateral trust bonds -Equipment trust certificates -Collateralized mortgage obligations (CMOs) -Other asset-backed securities (ABS) a. Certificates for Automobile Receivables (CARs) b. Credit Card Receivables -Variable rate notes -Zero coupon and deep-discount bonds a. Minicoupon bonds b. Original-issue discount (OID) bonds c. Taxes due on the implied interest -High-yield bonds (speculative bonds and junk bonds) a. Non-investment grade with rating below BBB or Baa

International Bonds By Country - Japan

-Samurai bonds - yen denominated issued by non-Japanese firms in Japan -Euroyen bonds - yen denominated, sold outside Japan by non-Japanese firms

Treasury Inflation Protected Securities (TIPS)

-Treasury began issuing in January of 1997 -Appeals to investors that need or want a real risk-free rate. -Bond principal payment (and thus coupon payments) are indexed to the CPI for all urban users and thus adjusted every 3 months -There is a 3 month lag because it takes 3 months for the CPI-U to come out - The difference between the YTM of a treasury note and an equivalent TIPS is the expected inflation rate over the life of the bonds

International Bonds By Country - United States

-Yankee bonds register with SEC -Eurodollar bond market affected by changes in value of U.S. dollar

Municipal Bond Guarantees

1. Bond insured against default risk -Insurance is irrevocable for the life of the issue -Covered about 50% of issues pre-crisis, 5% post-crisis 2. Four private bond insurance carriers -Municipal Bond Investors Assurance (MBIA) -American Municipal Bond Assurance Corporation (AMBAC) -Financial Security Assurance -Financial Guaranty Insurance Company (FGIC) 3. Insured bonds obtain AAA (Aaa) ratings 4. Issues with private guarantees have more active secondary market, and lower required yield

US Corporate Debt Market

Dominated by Utilities Other important segments: industrial, transportation, and financial Most bonds have -Semi-annual interest payments -Sinking funds -Single maturity date -Maturity of 25 to 30 years -Deferred calls after 5 to 10 years Most notes have -Maturity 5 to 7 years -Noncallable -Issued when rates are high

Equivalent Taxable Yield

ETY = i/(1-T) i = promised yield on tax-exempt investment T = marginal tax rate

Ratings Services

Fitch Investors Service Moody's Standard & Poor's Rated AAA, AA, A, BBB,BB, B, CCC, CC, C, D Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, D (Moody's) Will use "+" and "-" or numbers 1,2,3 (Moody's) Non-rated bonds - Must pay to get rated

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 -Eurodollar bonds are U.S. dollar denominated bonds issued by a foreign firm and sold outside the U.S.

Participating Investors

Individual investors Institutional investors Life Insurance Companies Commercial Banks Property and Liability Insurance Companies Pension Funds Mutual Funds

Bond Characteristics

Intrinsic Features 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 Features Affecting Bond Maturity Callable (call premium) / Noncallable Deferred call Nonrefunding provision Sinking fund

Bond Rating Categories

Investment Grade Rated AAA (Aaa) to BBB (Baa) Min. grade for many Pension Funds and Trusts Speculative Grade Rated BB (Ba) or below High-Yield Bonds Junk Bonds Flat In arrears on interest payments

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

Accrued Interest

Must be added to price quoted to get the cash price -Not sensitive to interest rate changes or credit rating -Earned each day -It is how much (in $) of the next coupon the current bond holder has already earned

The Global Bond-Market Structure

Participating issuers 1. Federal governments 2. Agencies of the federal government 3. Municipalities (State and local political subdivisions) 4. Corporations 5. International issues -Foreign bonds -Eurobonds

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

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 Germany -Federal Railway and Federal Post Office UK -none

Domestic Government Bonds

United States T-bills, notes, bonds, TIPS Japan Medium-term, long-term, super long-term Germany bund bonds, contract with Kassenverien United Kingdom short gilts, medium gilts, long gilts