Chapter 7 Bond Markets

Chapter 7: Bond Markets
Chapter 7: Bond Markets
Chapter Outline:
• Introduction to Bonds.
• Treasury and Federal Agency Bonds.
• Municipal Bonds.
• Corporate Bonds.
• Institutional Use of Bond Markets.
• Globalization of Bond Markets.
1-2
Introduction to Bonds:
• A bond is a long-term debt security.

• The bond is issued by the borrower (i.e. the
issuer) who promises to make payments of
interest and principal, on specific dates, to the
lenders (i.e. the bondholders).
Introduction to Bonds:
Who issues bonds?

• The U.S. federal government
• State and local governments
• Corporations
• Foreign governments or corporations
Valuation: Determining the
Intrinsic Value
• Intrinsic Value: the present value of the

future cash flows provided by the security.
CF1 CF2 CFn

Value = + ...
(1 + k) 1
(1 + k) 2
(1 + k)n
Key Characteristics of Bonds
• Par value: face amount; paid at maturity.

Normally in denominations of $1,000.
• Coupon interest rate: stated annual interest
rate on a bond. Multiply by par value to get
the annual interest payment (coupon
payment). Most bonds have fixed coupon
rate.
Special Types of Bonds
• Zero coupon bond: a bond that pays no

annual interest; it provides compensation to
investors in the form of capital appreciation.
• Floating rate bond: a bond whose coupon
rate fluctuates with shifts in the general
level of interest rates.
• Maturity date: a specified date on which

the par value is repaid.
• Term to maturity: the length of time until
maturity date.
• Payment pattern: the frequency of the
interest payments. Most bonds in the U.S.
pay interest semiannually.
• Bond ratings: ratings on corporate bonds

that provide an indication of default risk.
• Current yield: the ratio of the annual
interest payment to the bond’s market price.
Yield-to-Maturity:
• Yield to maturity (YTM) is the rate of

return earned on a bond held to maturity.
• It is the discount rate that equates the
present value of the future cash flows with
the current market price of the bond.
Yield-to-Maturity:
• Represents investor’s total return from settlement day until
security expiration
• Allows investors to compare bonds with different
maturities and coupon rates via internal rate of return
calculations
• Bond yields inversely related to bond prices
 Common maturities:
 short term: up to five years
 medium term: 5-12 years
 long term: 12 or more years
Treasury and Federal Agency Bonds:
• Treasury Bond Auction.

• Trading Treasury Bonds.
• Treasury Bond Quotations.
• Stripped Treasury Bonds.
• Inflation-Indexed Treasury Bonds.
• Savings Bonds.
• Federal Agency Bonds.
Municipal Bonds:
• Credit Risk.
• Characteristics of Municipal Bonds.
• Trading and Quotations.
• Yields offered on Municipal Bonds.
• Yield Curve on Municipal Bonds.
Corporate Bonds:
• Definition.
• Maturities.
• Yield Curve.
• Default Rate.
• Assessment of Risk.
• Bond Ratings.
• Private Placement of Corporate Bonds.
Corporate Bonds:
Characteristics of Corporate Bonds:

• Sinking-Fund Provision.
• Protective Covenants.
• Call Provisions.
• Bond Collateral.
• Low and Zero Coupon Bonds.
• Variable Rate Bonds.
• Convertibility.
Corporate Bonds:
• Trading Corporate Bonds.

• Types of orders:
Market Order.
Limit Order.
• Trading online.
• Corporate Bond Quotations.
Junk Bonds:
• Definition.
• Junk Bonds Market.
• Participation in the Junk Bonds Market.
• Risk Premium of the Junk Bonds.
• Performance of Junk Bonds.
• Contagion Effects in the Junk Bond Market.
Corporate Bonds:
• Using Bonds to Finance a Leveraged Buyout

(LBO).
• Using Bonds to Revise the Capital Structure.
– Debt for equity swap.
– Equity for debt swap.
Institutional Use of Bond Markets:
• See Page 178.

Globalization of Bonds Markets:
• Introduction.
• Eurobond Market.
• Government Bonds (Sovereign Bonds).
• Global Junk Bonds.
End of Chapter 7

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Chapter 7: Bond Markets

Chapter 7: Bond Markets

• A bond is a long-term debt security.

Who issues bonds?

• Intrinsic Value: the present value of the

CF1 CF2 CFn

• Par value: face amount; paid at maturity.

• Zero coupon bond: a bond that pays no

• Maturity date: a specified date on which

• Bond ratings: ratings on corporate bonds

• Yield to maturity (YTM) is the rate of

• Treasury Bond Auction.

Characteristics of Corporate Bonds:

• Trading Corporate Bonds.

• Using Bonds to Finance a Leveraged Buyout

• See Page 178.

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