THE BOND MARKET

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THE BOND MARKET

• A Deeper Understanding of a Major Economic Market
• Emma Ricci

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WHAT IS A BOND?

• A bond is a debt security, similar to an I.O.U.
  When you purchase a bond, you are lending money
  to a government, municipality, corporation,
  federal agency or other entity known as the
  issuer.
• Bonds issued by corporations or the US government
  are usually taxable
• Bonds issued by state governments or
  municipalities are usually exempt from tax

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Components

• The issuer, similar to a holder of an option
• Principal amount
• Specified interest rate paid to the issuer
  yearly (also known as the coupon)
• Date of maturity

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Variables that Effect Value

• Maturity
• Redemption Features
• Credit Quality
• Interest Rate
• Price
• Yield
• Tax Status

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MATURITY

• 1.Short-term notes maturities of up to 4 years
• 2.Medium-term notes/bonds maturities of five to
  12 years
• 3.Long-term bonds maturities of 12 or
  more years.

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REDEMPTION FEATURES

• Bond with a redemption provision usually have
  higher return to compensate for the risk that the
  bonds might be called early.
• CALL Option provisions that allow or require the
  issuer to repay the investors principal at a
  specified date before maturity.
• PUT Option option of requiring the issuer to
  repurchase the bonds, at a specified time, prior
  to maturity.

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CREDIT RATINGS

• Each of the agencies assigns its ratings based on
  an in-depth analysis of the issuer's financial
  condition and management, economic and debt
  characteristics, and the specific revenue sources
  securing the bond.

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INTEREST RATES

• FIXED Stays same until maturity ie buy a
  1000 bond with 8 fixed interest rate and you
  will receive 80 every year until maturity and at
  maturity you will receive the 1000 back.
• FLOATING adjustable to prevailing market rates.
  
• PAYABLE AT MATURITY receive no payments until
  maturity and at that time you receive principal
  plus the total interest earned compounded
  semi-annually at the initial interest rate.

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PRICE

• The amount you pay for the bond
• Newly issued bonds will pay close to their
  face-value
• Traded bonds fluctuate in response to changing
  interest rates
• Bonds traded higher than their face-value are
  said to be sold at a premium
• Bonds traded lower than their face-value are said
  to be be sold at discount

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YIELD

• Yield is the return you actually earn on the
  bond--based on the price you
  paid and the interest
  payment you receive
• Two Types of Yields
• Current Yield annual return on the dollar
  amount paid for the bond and is derived by
  dividing the bond's interest payment by its
  purchase price
• Yield To Maturity total return you will
  receive by holding the bond until it matures or
  is called.

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YIELD contd

• From the time a bond is originally issued until
  the day it matures, its price in the marketplace
  will fluctuate according to changes in market
  conditions or credit quality. The constant
  fluctuation in price is true of individual
  bonds-and true of the entire
  bond market-with every
  change in the level of interest rates typically
  having an immediate, and predictable, effect on
  the prices of bonds.

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YIELD (Linking price and yield)

• Most important thing to remember!!!!
• When prevailing interest rates rise, prices of
  outstanding bonds fall to bring the yield of
  older bonds into line with higher-interest new
  issues
• When prevailing prices fall, prices of
  outstanding bonds rise, until the yield of older
  bonds is low enough to match the lower interest
  rate on new issues.

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YIELD (Linking interest rate and maturity)

• The longer it takes for a bond to mature, the
  greater the risk that prices will fluctuate along
  the way
• By watching a yield curve you can gain a sense of
  where the market perceives interest rates to be
  headed

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TAXABLE STATUS

• Some bonds offer special tax advantages.
  There is no state or local income tax
  on the interest from U.S. Treasury bonds, and no
• federal income tax on the interest from most
  municipal bonds, and in many cases no state or
  local income tax, as well.

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INTEREST RATE-INFLATION

• As a general rule the bond market, and the
  overall economy, benefit from steady, sustainable
  growth rates.
• But steep rises in economic growth can lead to
  inflation, which raises the costs of goods and
  services for everyone, leads to higher interest
  rates and erodes a bond's value.

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INTEREST RATE-INFLATION

• Interest rates rise due to
• The Federal Reserve trying to slow economic
  growth
• through market forces acting in anticipation of
  interest rate moves
• Since rising interest rates push bond prices
  down, the bond market tends to react negatively
  to reports about strong economic growth.

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TYPES OF BONDS

• Municipal issued to raise money for schools,
  hospitals, highways, etc.
• Corporate debt obligations issued by private and
  public corporations
• Zero-Coupon Bonds with no periodic interest
  payments (introduced to the marketplace in 1982)

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MARKETABLILITY

• How quickly and easily a bond can be bought or
  sold
• For a bond to have high marketability, there must
  be a large trading volume as well as a large
  number of dealers in the security

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Bond Market Tables

• Example of Treasury table would look as follows
• RATE MATURITY BID ASK YLD
• 7 3/4 Feb. 01 10512 10514
  5.5
• 5 3/8 Feb. 01 9926 9927
  5.44

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Bond Market Tables

• Example of Tax-exempt
• ISSUE COUPON MAT PRICE YLD to MAT
• GO bonds 5.00 5-15-28 97 1/8
  5.19
• Public Power 5.00 1-1-28 97
  5.2
• District

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Bond Market Tables

• Example of Corporate Exchange Traded bonds
• BONDS Cur Yld Vol. Close Net chg
• BosCel 6s38 9.2 22 65 3/8
  1/4
• PacBel 65/8s34 6.7 5 991/8 -1/8

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BOND BENEFITS

• Some portion of portfolio should be in bonds
• High degree of safety with regular, scheduled,
  predictable payments