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Bond : The Basicsby Binam Ghimire
Learning Objectives
Understand the meaning and terminologies in bond
Understand types and feature of bond Bond Ratings
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Fixed Income Securities
Pure-discount security Coupon Security
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Fixed Income Securities
Personal Savings – in a Commercial Bank: Demand Deposits, time-deposits, Certificates of deposits and Jumbos
Money Market Instruments: Commercial Paper, CDs, Bankers’ Acceptances, Eurodollars, Repurchase Agreements
Bond
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Bond: What is it?
IOU Long term fund requirement: issue bonds Bond meaning: IOU certificate in which a
company promise to make a series of fixed interest payments and in the end repay the debt
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Bond: What is it?
From Paper to Electronic recording
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Bond:Terminologies
Price = ? Yield = ? Coupon = ? The price of the bond is ……….. per ………….. Therefore to buy ……………….. face value of this
bond would cost …………….. You would receive ……………….. per annum per
€100 of bond held A holder of €1000 bond would receive
……………….. on the 4th Sept. each year
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Bond:Terminologies
10Y Benchmark Bund 1.5% 4/9/22 Price = 101.154, Yield = 1.372%
A 10 year German Government AAA rated debt security, offering a 1.5% fixed coupon (paid once per year)
The price of the bond is €101.154 per €100 Therefore to buy €1000 face value of this bond
would cost €1011.54 Coupon -You would receive €100 x 1.5% per
annum per €100 of bond held A holder of €1000 bond would receive €15 on the
4th Sept. each year
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Bond:Terminologies
Yield to Maturity (YTM) YTM is the interest rate that makes the present
value of a bond’s payments equal to its price. The YTM incorporates both the coupon return
plus any capital gain or loss from holding the bond to maturity (…………….%)
Redemption Value and Maturity date 100% face value repaid on ……………….. Basis Day count convention is
…………………/………………
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Bond:Terminologies
Yield to Maturity (YTM) The YTM incorporates both the coupon return
plus any capital gain or loss from holding the bond to maturity (1.372%)
Redemption Value and Maturity date 100% face value repaid on 4th September 2022 Basis Day count convention is Actual/Actual
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Bond:Conventions
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See excel file
Bond:Types (Issuers)
Treasury Bond: Government Corporate Bond: Companies Municipal Bond: State or local government Foreign Bond: Foreign government/ companies
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Bond:Types (Cash Flows)
Pure Discount Bonds Level Coupon Bonds Consols
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BondsTypes (Nature)
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Redeemable Irredeemable Convertible Non-convertible Extendable/ Retractable Zero coupon/ Strip Junk/ high yield/ non investment grade Eurobonds Inflation linked Puttable Floating Preferred stock ….
BondsTypes (Innovations)
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Inverse Floaters Asset-Backed Bonds Catastrophe Bonds Indexed Bonds
Bondsmore …
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The indenture Call provisions Sinking Funds Private Placements Bankruptcy, Distressed Securities
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Bond Ratings
Bonds of the same maturity offer a different rate of return
Why ?Due to the risk of defaultThe difference between the return on “safe”
bonds (i.e. government) and “risky” bonds is called a default premium
How do you assess risk ?Moodys and S&P - evidence suggest that low
ranked bonds promise higher returns
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Bond Ratings
Since the primary function of bonds as an investment vehicle is to make fixed payments, it's essential that the company or government issuing the debt has the ability to make all payments on time and in full. Bond ratings evaluate the debt issuer to determine the risk of default
The leading rating agencies, Standard & Poor's and Moody's Investors Services, assign ratings when a bond is first issued, and that rating helps determine how high the bond's interest rate will be. If the agencies assign a high rating, that means there's little risk of default, so the issuer can obtain a lower interest rate
While the rating systems of Moody's and S&P differ somewhat, they're more alike than different. Both agencies have investment-grade ratings, which connote a high level of creditworthiness, and speculative ratings, which mean higher risk levels and merit higher interest rates
Here are Moody's ratings, from highest to lowest. Investment grade: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3. Speculative grade: Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C1
Here are S&P's ratings. Investment grade: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-. Speculative grade: BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, D
Thank you
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