Bonds, A Fixed Income Investment

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Bonds, AFixed Income Investment

• There is more to investing than stocks!!
• Hussain Dhala, BMOS 2
• Healthcare Analyst
• Western Investment Club

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What is Fixed Income?

• A financial instrument that has a fixed stream of
  payments resulting from an initial investment.
• Unlike stocks where dividends are not fixed.
• The price of a fixed income instrument is greatly
  affected by the interest rate, and hence, by
  prevailing macroeconomic conditions.

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Types of Fixed Income Investments

• Bonds
• Investment Grade
• High Yield
• Money Market Instruments
• T-Bill
• GIC

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Bond Terminology

• Issuer the corporation or government that is
  borrowing money (selling bonds).
• Bondholder the institution or individual that
  lends money (buys bonds).
• Par or Face Value the principal amount of the
  bond.
• Coupon rate the interest rate paid by the issuer
  to the bondholder.

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Bond Terminology (contd)

• Coupon payment the fixed payment made to the
  bondholder.
• Maturity the date on which the bond expires and
  when the issuer repays the principal to the
  bondholder.
• Default risk risk associated with the issuer not
  being able to meet the required coupon payments

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What are Bonds?

• In simple terms a bond is a loan made from the
  investor to the issuer of the bond.
• Represents an IOU with certain terms in the
  contract.
• The issuer pays interest on the loan at fixed
  time intervals.
• When the bond matures, the investor receives the
  principal of the loan back.

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Types of bonds by credit rating

• Bonds come in many variations
• Issuer
• Government
• Provincial
• Municipal
• Corporate
• Investment Grade
• High Yield (Junk)

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Default Risk

• There is always a chance that the issuer of a
  bond will not be able to fulfill the obligation
  to make interest (coupon) payments.
• Rating agencies such as SPs and Moodys rate
  the default risk of various institutions.
• The more risk associated with a bond, the higher
  the coupon rate of the bond will have to be to
  compensate investors.
• HIGH RISK HIGH RETURN

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Bond Ratings
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Bond Prices

• Bonds can be bought and sold on the open market
  from one investor to the next after the company
  has issued them.
• Whats the price of a bond determined by?
• Time value of money (current and future interest
  rates)
• Time to the maturity of the bond.
• Changes in credit rating (default risk).

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The Dynamics of Bond Prices

• If the interest rate goes up, bond prices fall.
• If the interest rate goes down, bond prices rise.

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Bonds vs. Bank Loans

• Why doesnt a company wishing to raise capital
  just take a loan from the bank?
• Banks dont always have enough money or are not
  willing to lend that much!
• Banks will often place restrictions on a company
  in order to lend them money. Bondholders cant.
• By splitting debt up into smaller securities, can
  access a larger market for their debt.
• Can issue bonds in all sorts of flavours to
  tailor the debt offering more to the firms needs.

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Various Types Of Bonds

• Callable Bonds
• Puttable Bonds
• Sinking Fund Bonds
• Extendable Bonds
• Convertible Bonds

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Some thoughts on bonds

• Bonds are often overlooked in bull markets
  because they provide a less significant return.
• They are generally a safer investment than
  stocks, and can be used for retirement planning.
• Bonds are logical investments for insurance
  companies or pension funds which need to meet
  their liabilities and benefit from having
  instruments with fixed payments.

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Bond Resources

• Investopedia (www.investopedia.com)
• Basic Bond Tutorial
• Advanced Bond Tutorial
• Liars Poker by Michael Lewis
• The experiences of a bond salesman at Salomon
  Brothers
• The Handbook of Fixed Income Securities by Frank
  J. Fabozzi
• A HEAVY READ