Series 7; Ch. 2

Front 1

Bonds are issued by?

Back 1

-Corporations

-State & Local Gov't & their agencies (Municipals)

-Federal Gov't & its agencies (US Gov't Debt)

Front 2

Principal

Back 2

Amount that an issuer will repay to the bond holder when bond matures.

Amount owed @ maturity is also referred to as the par value of the bond.

Front 3

Coupon

Back 3

Rate of interest paid on the bond & is also referred to as the Nominal Yield.

Rate of return which is set @ issuance & does not change.

Interest payments are semi-annually.

Front 4

Zero-Coupon Bonds

Back 4

Pay no semi-annual interest.

Issued @ a deep discount & mature @ par.

Difference between the price paid & par is considered to be the interest.

Front 5

Maturity Date

Back 5

Date on which the last semi-annual interest payment is made & the principal is paid back.

Front 6

Types of Bonds

Back 6

1) Bearer Bonds

2) Registered as to Principal only

3) Fully registered

4) Book Entry

Front 7

Bearer Bonds

Back 7

-Physical certificate is issued.

-Coupons representing interest payments are attached & must be redeemed to receive interest payments.

-Interest & principal payments are NOT registered

-NO record of ownership is kept by the issuer

-NO longer issued

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Registered as to Principal Only

Back 8

-Principal & interest payments are registered.

-Interest payments are in bearer form.

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Fully Registered

Back 9

-Principal & Interest payments are registered

-Physical certificates are still issued

Front 10

Book Entry

Back 10

-Principal & Interest payments are registered.

-No physical certificates are issued.

-All records are kept on a computer.

Front 11

Types of Bond Issues

Back 11

1)Term Issues (Dollar Bonds)

2)Serial Issue

3)Series Issue

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Term Issues (Dollar Bonds)

Back 12

-SAME issuance, coupon, maturity

-Most corporate & gov't bonds

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Serial Issue

Back 13

-Same issuance, Differing coupons, differing maturities

-Longer maturities = higher coupons

-Balloon Maturity: Most of the issue will be maturing @ one time.

-MOst municipal bonds

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Series Issue

Back 14

-Differing issuance, Same maturity, Differing coupons

-Earlier issuance = Higher coupons

-Long term construction projects

Front 15

Dollar Pricing

Back 15

-Expressed as a % of par

-Most term issues are quoted this way

-Corporate bonds are quoted in eighths

-Gov't notes, bonds & agencies are quoted in 1/32nds

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Yield Pricing

Yield Basis

Basis Quote

Yield to Maturity

Back 16

-Most municipals are quoted

-Quoted on basis points
*1 basis point = .01% of par (10 cents)
*10 basis points = .1% of par ($1)
*100 basis points = 1% of par ($10)

-Basis points are an expression of yields

Front 17

Bond Yields

Back 17

-Bond prices & interest rates have an INVERSE RELATIONSHIP.
When one goes up, the other goes down.

-Yields move in the manner represented on the bond see-saw.

Front 18

Yield to Call

Back 18

Yield on the bond if the issuer redeems the bonds prior to maturity

Usually the issuer will call the bond @ premium to bond's par value

Front 19

Yield to Maturity

Back 19

Yield on the bond if the issuer redeems the bond on its maturity date @ par value.

Most important because of "time value" of money

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Current Yield

Back 20

Used as a measure of how much interest payment is worth compared to the current market price of the bond.

Front 21

Formula: Current Yield

Back 21

Annual Interest Payments / Market Price = Current Yield

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Nominal Yield

Back 22

Stated coupon on the bond.

Yield will NEVER change unless the issuer is permitted to change the bond's coupon.

Front 23

Worst Case Pricing

Back 23

Quote either

Yield to Call

Yield to Maturity

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Discount Bonds

Back 24

Yield to Call would be the higher yield

If bond is NEVER CALLED, then it's Yield to Maturity is lower.

ALWAYS QUOTE @ the lower Yield to Maturity

Front 25

Premium Bonds

Back 25

Yield to Maturity would be the higher yield

If Bond is CALLED, then it's yield would be Yield to Call which is lower.

MOST OFTEN, quote Yield to CALL

Front 26

The Yield Curve

Back 26

Short term bonds have lower yields, while longer term bonds have higher yields.

Front 27

Inverted Yield Curve

Back 27

Occurs during troubled economic times

During Inflation, Feds tighten up money supply, where Short term maturities will actually yield more than long term maturies.

Feds are trying to take money out of system by making short therm borrowing less attractive.

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Yield Rules

Back 28

1) Short term yields fluctuate more than long term yields

2) Long term bond prices fluctuate more than short term bond prices

3) Discount bond prices fluctuate more than premium bond prices

4) If bonds are of equal maturity, then the one with lower coupon will have the greater price votality. Long term low yielding discount (Zero Coupons) bonds are the most volatile

Front 29

Interest Rate Risk

Back 29

Rising interest rates will cause bond prices to fall

Long term deep discount bonds are most susceptible

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Purchasing Power Risk

Back 30

Inflation will lower the value of interest & principal payments causing bond prices to fall

Front 31

Marketability Risk

Liquidity Risk

Back 31

Some bonds may be more difficult to sell

Small thinly traded issues are most susceptible

Short term + High quality = very liquid

Long term + Low quality = less liquid

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Legislative Risk

Back 32

New laws may adversely affect bond holders, i.e. TAX LAWS

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Call Risk

Back 33

When interest rates are low, bond prices are higher.

Issuers may take advantage of this situation by calling in their bonds early during periods of low interest rates

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Reinvestment Risk

Back 34

When interest rates fall, interest payments & principal payments will have to be reinvested into lower yielding issues.

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Credit Risk

Back 35

A measure of the issuer's ability to pay interest & principal payments in a timely fashion.

When an issuer's credit rating is lowered, their outstanding bonds will fall in value.

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Bond Ratings - Investment Grades

Back 36

1) Standard & Poor's

2) Moody's

Front 37

Callable Bonds

Back 37

-Allow the issuer to retire the bonds prior to maturity date.

-Bonds are more likely to be called during periods of low interest rates.

During low interest rate periods, issuers can issue new bonds @ lower rates; thereby reducing their debt service.

Trust Indenture: Provisions of the Call

Sinking Fund: Account where the issuer makes annual deposits that would be used to retire the bonds.

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Call Protection

Back 38

Certain period of time after the bond's issuance when it can not be called (Usually the 1st 5 to 10 years).

Call Premium: Amount paid above par

Front 39

Puttable bonds

Back 39

Some bonds allow the holder to sell (put) the bond back to the issuer.

Typically found on bonds which reset their coupons every year.

Some allow the bond holder to redeem the bond with the issuer for cash if the coupon is lowered, rather than lower interest payments.