CHAPTER FOUR BOND FUNDAMENTALS 3 Practical Investment Management Robert A Strong
BOND FUNDAMENTALS CHAPTER FOUR Practical Investment Management Robert A. Strong 1
Bond Principles: Identification of Bonds Bonds are identified by issuer, coupon rate, and maturity. The face value of a bond is called its par value eg.5of“ Hertz sevens of03”( Hertz7s03) A legal document called the indenture contains the details of the bond issue Strong c4- Bond fundamentals 4-2
4 - 2 Strong C4 – Bond Fundamentals Bond Principles: Identification of Bonds Bonds are identified by issuer, coupon rate, and maturity. The face value of a bond is called its par value. e.g. 5 of “Hertz sevens of 03” (Hertz 7s03) A legal document called the indenture contains the details of the bond issue
Bond Principles: Classification of Bonds Method 1: By issuer a government e.g. US Treasury, federal agency, state, local b corporation e.g. industrial, utility, financial, transportation C.others e.g. foreign government, foreign corporation, World Bank Strong c4- Bond fundamentals 4-3
4 - 3 Strong C4 – Bond Fundamentals a. government e.g. US Treasury, federal agency, state, local b. corporation e.g. industrial, utility, financial, transportation c. others e.g. foreign government, foreign corporation, World Bank Bond Principles: Classification of Bonds Method 1: By issuer
Bond Principles: Classification of Bonds Government Corporation Other U.S. Treasury Industrial Foreign Government Federal Agency Utility Foreign Corporation State Financial World Bank Local Transportation *Earlier this century, railroads would have also appeared on this list Strong c4- Bond fundamentals 4-4
4 - 4 Strong C4 – Bond Fundamentals Bond Principles: Classification of Bonds Insert Table 4-1 here
Bond Principles: Classification of Bonds Method 2 By security a unsecured debt backed by faith in the taxing power of the government, or the good name of the company(debenture) b. secured debt e.g. revenue bond, assessment bond, mortgage, collateral trust bond, equipment trust certificate Bond security sometimes comes from non-traditional sources. Recently, some rock stars floated bonds using their future earnings as backing Strong c4- Bond fundamentals 4-5
4 - 5 Strong C4 – Bond Fundamentals a. unsecured debt - backed by faith in the taxing power of the government, or the good name of the company (debenture) b. secured debt e.g. revenue bond, assessment bond, mortgage, collateral trust bond, equipment trust certificate Bond security sometimes comes from non-traditional sources. Recently, some rock stars floated bonds using their future earnings as backing. Method 2: By security Bond Principles: Classification of Bonds
Bond Principles: Classification of Bonds Method 3: By term a short-term - a year e. g. US Treasury bills b intermediate-term e.g. US Treasury notes (2 to 10 years) C long-term e.g. US Treasury bonds(2 10 years) d open-ended e.g. corporate line of credit e serial bond -a portfolio of bonds with staggered terms Strong c4- Bond fundamentals 4-6
4 - 6 Strong C4 – Bond Fundamentals Method 3: By term a. short-term - a year e.g. US Treasury bills b. intermediate-term e.g. US Treasury notes (2 to 10 years ) c. long-term e.g. US Treasury bonds ( 10 years) d. open-ended e.g. corporate line of credit e. serial bond - a portfolio of bonds with staggered terms Bond Principles: Classification of Bonds
Bond Principles: Classification of Bonds ype Maturty Issued Bills 4. 13 and 26 weeks Weekl Notes 2 years Monthly Notes 5 and 10 years February, May, August, N ovember Inflation-adjusted Note 10 years January, July, October B onds Over 10 years February, May, August November The minimum purchase for all securities is $1,000 Source: Federal reserve Bank of New York Strong c4- Bond fundamentals 4-7
4 - 7 Strong C4 – Bond Fundamentals Bond Principles: Classification of Bonds Insert Table 4-2 here
Bond Principles: Terms of Repayment o interest only the periodic payments are entirely interest o sinking fund-periodically, a portion of the debt principal is set aside or a certain number of the bonds is retired balloon loan-the debt may be partially amortized with each payment income bond-interest is payable only if it is earned Strong c4- Bond fundamentals 4-8
4 - 8 Strong C4 – Bond Fundamentals ◆ interest only - the periodic payments are entirely interest ◆ sinking fund - periodically, a portion of the debt principal is set aside or a certain number of the bonds is retired ◆ balloon loan - the debt may be partially amortized with each payment ◆ income bond- interest is payable only if it is earned Bond Principles: Terms of Repayment
Bond Principles: Bond Cash Flows annuities- most bonds are annuities plus an ultimate repayment of principal o zero coupon-only the par value is returned at maturity variable(adjustable) rate-the rate fluctuates in accordance with some market index or predetermined schedule consols-a level rate of interest is paid perpetually inflation-indexed Treasury bonds-the principal value is adjusted based on the consumer price index South-Western /Thomson Leaming@ 2004 4-9
◆ annuities - most bonds are annuities plus an ultimate repayment of principal ◆ zero coupon - only the par value is returned at maturity ◆ variable (adjustable) rate - the rate fluctuates in accordance with some market index or predetermined schedule ◆ consols - a level rate of interest is paid perpetually ◆ inflation-indexed Treasury bonds - the principal value is adjusted based on the consumer price index South-Western / Thomson Learning © 2004 4 - 9 Bond Principles: Bond Cash Flows
Bond principles: Options convertible bond-may be exchanged for common stock in the company that issued the bond exchangeable bond-may be exchanged for shares in another firm Strong c4- Bond fundamentals 4-10
4 - 10 Strong C4 – Bond Fundamentals ◆ convertible bond - may be exchanged for common stock in the company that issued the bond ◆ exchangeable bond - may be exchanged for shares in another firm Bond Principles: Options
