Security Industry

Essential (S I E)
Chapter 5 Bond RICKY WANG

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Overview BASICS

FEDERAL INSTRUMENTS

C O R P O R AT E B O N D S

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BASICS FEDERAL INSTRUMENTS C O R P O R AT E B O N D S

Varying Maturities Varying Maturities

Bond Income A key feature of any bond is its term to maturity, the number of years during which the
borrower has promised to meet the conditions of the debt. A bond's maturity is the date
Coupon Value on which the debt will be repaid. The borrower redeems the issue by paying the face value
or principal
Par Value

Yields

Callable & Convertible

Ratings

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• Varying Maturities Varying Maturities

Bond Income
A key feature of any bond is its term to maturity, the number of years during which the
Coupon Value borrower has promised to meet the conditions of the debt. A bond's maturity is the date
on which the debt will be repaid. The borrower redeems the issue by paying the face value
Par Value or principal.

Yields
Bonds are typically classified as short term, intermediate term or long term, depending on
Callable & Convertible the number of years before they mature:
• Short term: in less than 2 years; Bill
Ratings • Intermediate: 2 to 10 years; Note
• Long term: more than 10 years. Bond

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• Varying Maturities Term & Serial Bonds

Bond Income
A term bond is a bond issue consisting of a number of bonds that are issued by the same
Coupon Value borrower and mature on the same date. For example, a company issues $5 million worth of
bonds, all of which mature in 10 years
Par Value

Yields
Serial bonds have varying maturity dates, or serial maturities, spread out over a number of
Callable & Convertible years.In other words, with a serial bond, a certain portion of the bond issue matures at regular
intervals until the entire issue is retired. For example, an issuer issues a $50 million serial bond, of
Ratings which $5 million of principal is paid every year until the principal is repaid in full.

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Varying Maturities
Generate Income
• Bond Income Bonds provide investors with two kinds of income:
Coupon Value

Par Value • Coupon income is derived from the steady stream of semiannual income, also known as the
coupon, paid by the issuer of the bond during the life of the bond.
Yields
• Capital gains are earned when a bond matures or is sold at a price above the amount that
the bondholder originally paid. For example, if a bond was purchased at a discount to its par
Callable & Convertible
value, or less than $1,000 in the case of a corporate bond, the bondholder will realize a capital
gain when the bond matures at par. In addition, some bondholders may sell their bonds
Ratings
before maturity and realize a capital gain by selling above their adjusted cost basis.

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Varying Maturities
Coupon Value
Bond Income
The coupon on a bond is the annual interest payment made by bond issuers to bond owners
• Coupon Value during the life of the bond. It is generally paid semiannually. The coupon rate is always
calculated based on the bond's face or par value, and is quoted as a percentage of par.
Par Value

Yields For example, a bond with a par value of $1,000 and an annual interest rate of 10% has a
coupon rate of 10%. The annual interest per year is $100, with semiannual payments of $50
Callable & Convertible

Ratings

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Varying Maturities
Par Value
Bond Income
The par value, or face amount, of a bond is the value written on the front of the bond. This is
Coupon Value the amount of money that bond issuers have agreed to pay the bondholder on the date the
bond matures. For example, when a bond matures, the investor will get $1,000 par value, plus
• Par Value the last 6 months of interest because interest is paid in arrears.

Yields

Callable & Convertible

Ratings

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Varying Maturities Yields

Bond Income There are several different yields associated with a bond. First is the stated rate, also known as the
nominal yield or coupon rate. The three terms are synonymous. The stated rate is the rate at which
Coupon Value the issuing corporation has contracted to pay interest during the life of the bond. This rate never
changes; the issuer will pay the stated interest rate until the bond matures and is retired.
Par Value

• Yields The current yield is calculated by dividing the annual interest by the current market value of the
security rather than the face amount (or par value) of the bond.
Callable & Convertible
A bond’s current yield represents the return on investment by relating the annual coupon rate to the
current price of the bond.
Ratings
If a bond with a par value of $1,000 was purchased for $1100, and paid a coupon rate of 5%, its
current yield is calculated as follows: 10 years

Current Yield = ($1,000 * 5%)/ $1100 = $50/$1100= 4.55%

YTM=500+ （ 1000 - 1100）= 500- 100 / 902= 44.35% /10= 4.435%

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Yield To Maturity (Y T M)
Varying Maturities

The Yield to Maturity(YTM), expressed as a percentage, is the total return that would be realized on a
Bond Income
bond or other fixed income security if the bond were held until the maturity date. Yield to maturity may
be greater than the current yield (if the bond is selling at a discount) or less than the current yield (if the
Coupon Value
bond is selling at a premium).

Par Value
Yield To Call (Y T C)
• Yields
Yield to call (or YTC) evaluates the performance of a callable bond from purchase to the call date.It is
Callable & Convertible
the yield realized on a callable bond if the bond was redeemed by the issuer on the next available call
date. YTC is similar to YTM except that the investor's holding period is assumed to end on the call
Ratings
date; not the maturity date.

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Callable & Convertible Bond

Varying Maturities
Callable bond
Bond Income
Most issuers of corporate debt have call features, which give the corporation the flexibility to retire
debt prior to maturity. Such features are of benefit to issuers because they allow them to retire the
Coupon Value
bonds at their option. The call provision of a bond specifies the call date and call price.

Par Value The call premium is the price above the par value of a bond that the issuer must pay the
bondholders when the issuer calls, or redeems, the bond early.
Yields
Convertible bond
• Callable & Convertible A convertible bond is convertible into the common stock of the issuer at the bondholder’s discretion.
Conversion is optional, and the investor may choose never to convert.
Ratings

The conversion price and conversion ratio are determined at issuance. For example, assume a 6%,
10-year bond that converts into the issuer’s common stock at $40 per share. Since the bond’s par
value equals $1,000, the investor would receive 25 shares upon conversion. We know this by dividing
par value by the conversion price: $1,000 ÷ $40 = 25 shares of common stock upon conversion
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Premium & Discount

Varying Maturities
Bond yields move in the opposite direction of bond prices; therefore, when a bond is selling above
Bond Income par, the current yield and yield to maturity, as well as the yield to call, are below the nominal yield. The
nominal yield is always fixed. It is the coupon rate determined at the time the bond is issued
Coupon Value
Bonds are quoted in terms of bond points, which represent a percentage of a bond's par value. For
Par Value example, if a bond is quoted at 101, you would simply multiply 101 by $10 to arrive at the bond price
of $1,010. This is a premium bond because it is priced above its par value of $1,000. If a bond is

• Yields quoted at 98, the price of a bond with a $1,000 par value would be $980 (98 multiplied by $10). This
is a discount bond because it is priced below its par value
Callable & Convertible
The last transaction in ABC 6.00s 2040 was 103. In this situation:
Ratings
• ABC is the bond;
• 6.00 is the interest rate;
• 2040 is the maturity date;
• $1,030 is the current price (multiply 103 by $10).

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Premium & Discount

Varying Maturities

Bond Income

Coupon Value

Par Value

• Yields
Callable & Convertible

Ratings

60/900=6.6%
60/1100= 5.5%
600+(1000- 900) =(700/900)/10= 7.7%
600+(1000-1100) = (500/1100 )/10= 4.7%
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Ratings
Varying Maturities
Bonds ratings, which are issued by bond rating agencies, reflect the issuer's ability to meet
Bond Income interest or principal payments on its bonds. The risk associated with meeting this obligation is
called credit risk, which is also known as business or default risk.
Coupon Value
One way to assess a bond's default risk is to check its credit rating. Most domestic bonds are rated
Par Value by one of the two major rating services: Moody's or Standard & Poor's (S&P).

Yields

Callable & Convertible

• Ratings

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Treasury Securities Treasury Securities

Agencies U.S. government securities, also known as Treasury Securities or simply Treasuries, are
considered very safe investments because they are backed by the full faith and credit of the United
States government. Treasuries are also highly liquid. There is a vast secondary market for
Treasuries, with high daily trading volume and numerous investors worldwide. Interest on Treasury
Securities is subject to federal taxation only, not to state and local tax. However, just like all other
bonds, capital gains realized from trading Treasuries are fully taxable.

Marketable securities can be traded for value in the secondary market. These include Treasury
bills, notes and bonds. Treasury bills, or T-Bills, have the shortest maturity, a maximum of 1 year.
T-Notes have maturities between 2 and 10 years, and T-Bonds have maturities greater than 10
years.

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Agencies
Treasury Securities

Some government agency issuers are backed by the full faith and credit of the U.S. government, and
Agencies
these government agency securities are exempt from registration under the Securities Act of 1933.

The majority of mortgage securities are issued and/or guaranteed by one of the following:

• An agency of the U.S. government;

• The Government National Mortgage Association, or Ginnie Mae (GNMA) — a government-owned

corporation within the Department of Housing and Urban Development, this is the only agency that
is government-guaranteed;

• Government-sponsored enterprises (GSEs), such as the Federal National Mortgage Association, or

Fannie Mae (FNMA) and the Federal Home Loan Mortgage Corporation, or Freddie Mac(FHLMC).
Both are chartered by Congress, but owned by stockholders.

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Secured Bond
• Secured Bond
Unsecured Bond
Mortgage bonds (most common type of secured bonds) are collateralized by a lien or mortgage
against real property. Corporations issue both first and second mortgage bonds. Of all secured
corporate debt, first mortgage bonds are considered the most senior with respect to a claim on
assets in the event of a foreclosure or liquidation.

Equipment trust certificates are usually issued by railroads and airlines, and are secured by railroad
cars and airplanes. Historically, these have proven to be secure investments because the bonds are
retired at a faster rate than the equipment is depreciated. With equipment trust certificates, it is
important to understand that it is the issuer who owns and operates the equipment; not the equipment
manufacturer.

Collateral trust certificates are backed by the securities of a different issuer.

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Secured Bond Unsecured Bond

• Unsecured Bond Debentures or unsecured corporate bonds, the most common type of unsecured debt, are
backed only by the full faith and credit of the issuer. There is no specific collateral backing, similar to a
signature loan. Because debentures are not backed by specific collateral, they carry more risk than
secured bonds.

Subordinated debentures are junior in claim to all other bonds. Because subordinated debentures
have a lower lien priority than all other bonds, they are the riskiest bond on a corporation's balance
sheet. Consequently, a subordinated debenture will have a higher yield than a debenture from the same
issuer.

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Secured Bond Question Time

• Unsecured Bond Which of the following corporate bonds is secured by real estate?

A. Mortgage bond

B. Equipment trust certificate

C. Debenture

D. Collateral trust bond

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Secured Bond Question Time

• Unsecured Bond Which of the following corporate bonds is secured by real estate?

A. Mortgage bond

B. Equipment trust certificate

C. Debenture

D. Collateral trust bond

Mortgage bonds are backed or secured by real estate so if the corporation defaults on the
bonds, the real estate will be sold to satisfy the bondholder’s claims

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Secured Bond Question Time

• Unsecured Bond Which one of the following securities is traded and quoted at a discount?

A. Corporate bonds

B. U.S. Treasury notes

C. Common Stock

D. U.S. Treasury bills

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Secured Bond Question Time

• Unsecured Bond Which one of the following securities is traded and quoted at a discount?

A. Corporate bonds

B. U.S. Treasury notes

C. Common Stock

D. U.S. Treasury bills

Of the securities listed here, only Treasury bills (T-Bills) are quoted at a discount. Treasury
notes (T-notes) have stated, or fixed, interest rates

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 BASICS FEDERAL INSTRUMENTS C O R P O R AT E B O N D S

Secured Bond Question Time

• Unsecured Bond Which of the following is measured by the yield-to-maturity?

A. The Return on a bond up to the call date

B. The return of an investment in relation to the degree of risk

C. The total return of a bond from the time of purchase until maturity

D. The return on a bond based on its current market value

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Secured Bond Question Time

• Unsecured Bond Which of the following is measured by the yield-to-maturity?

A. The Return on a bond up to the call date

B. The return of an investment in relation to the degree of risk

C. The total return of a bond from the time of purchase until maturity

D. The return on a bond based on its current market value

The yield-to-maturity measures the total return of a bond from the time of purchase until
maturity. The return of an investment in relation to the degree of risk taken is called the risk-
adjusted return. The current yield measures the interest rate that a security with a fixed
income is generating to the holder based on its current market value. The yield-to-call
measures the return on a bond similar to the yield-to-maturity, except that the ending period
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