3- Captial Markets - Bond Market

capital markets where bonds are traded

long term debt obligations issued by corporations and governments
- to raise funds to support long term operations
- in return, investor recieved specificed amount at maturity (face value) and coupon interest (coupon rate x face value)

amount of return an investor will get on a bond

maturity 1-10 years

maturity over 10 years

- local gov
maturity 1-30 years

- coporations
maturity 1-30 years

newly issued securities
- liquid

previoulsy issued, less liquid

maturity
- the more they are approaching maturity, the less liquid they are

full faith and credit of us government
- pay low interest rates

principal value does not change with inflation

interest rate is adjusted to reflect in inflation
- inflation, interest rises, + cost for the governement, + revenue for investors
- defltion, the interest decreases, - cost for government, - revenue for investors

treasury security which the period interest payment is seperated from the final pricipal payment
- creates 2 securities
- each compontent of the STRIPS = zero coupon bond
- can only be bought through financial institutions, borkers, and dealers

treasury inflation protected securities
- provide returns tied to inflation rate
- inflation adjusted principle: principle value can increase/decrease every 6 months by the amount of US inflation/deflation

legal contract that specifies the rights and obligations of the bond issuer and holder
- convenants = rules, restrictions, rights
- lowers the risk and interest cost of the bond (no uncertainty for external events)

oversees bond issuers performance and replayments
- bond holders representative

track records of bond holders

physical ownership of coupons, attached to bond and presented to issuer for payment when due

electronic ownership of coupon, owner registered by the issuer who mails the coupons to registered owner

entire issue matures on single date

portion of issue paid off on a series of dates

finance specific projects that are pledged as collaterol, it is secured so less risky

less than non mortgage bonds, increased security of mortgage decreases the risk which in turn decrease interest

unsecured bonds backed by creditworthyness of issuer

"high yield"/"junk bonds" that are unsecured and have below investment brand credit ratings

secured - senior - unsecured - subordinated (junior)
- subordinated are riskiest type

subordinated debentures have higher yield than debenture bonds because of the increased risk level

bonds that can be exhanged for other securities belonging to issuing firm (bond holder decides if to exchange)
- would be exchanged if market value of securities is greater than the market value of the bond
- hybrid securities involves elements of both debt and equity

non convertible bonds have a higher yeild

bond holder opportunity to purchase common stock at a preset price until a certain date
- warrant will be excercised if the market value stocks is greater than purchase price through the warrant
- bond holder keeps the bond, and pays the set price for additional stocks

include a call provision that allows issuer to require the bondholder to sell the bond back at a set call price (above par)
call price - face value = call premium
- called when interest rate drops, so issuer can issue new debt at lower interest rate

callable bonds have a high yield than non callable

requirement that issuer retires bonds previously issued early over a number of years
- money is set aside to retire bonds by buying them in the open market
- reduces the probability of default at maturity (increases attractiveness to investors)

sinking funds have a lower yield than non sinking funds due to the decreased default risk

municipal bonds that are issued to fund public projects, they are collateralized by the earnings from said project which repays the investors

through public sale (called issue) or private placement

exchange markt and over the counter market
- in contrast to t bonds, secondary market trading involves high degree of liquidity risk
- trading over the counter makes investors unsure about reliability of prices reported

2 transactions
- issuer to the investment bank, then investment bank to the insititutional investors

1 transaction
- issuer to investors where investment bank helps the issuer but is not a part of the transaction

direct transaction
- issuer to investors

investment bank issues securities by buying the whole issue at a fixed price, which guarantees the issuer a price and quantity
- then resells at higher price to investors
- the profit = spread: selling price - purchasing price
- investment bank takes on the risk that they may not be able to resell at the higher price
- bond issues can be bought through competitive bidding with other IB or through direct negotiation with the issuer
- safest procedure for companyov because they earn immediately from IB

investment bank acts as a distribution agent on a fee, does not guarantee a price to the issuer
- the fee is based on profit earned by the company on purchases from investors
- therefore IB acts in best effort but does not guarantee price or quantity sold to company

direct buy and sale without an IB
- can be unregistered and can be resold only to large, financially sophisticated investors (need expertise to analyze the security's risk)

based on perceived probability of default of issuer, ranked by bond rating agencies
- letter grade provides investors ability to make informed investment decisions

AAA
- lowest interest spread over similar maturity treasury securities as it has the lowest default risk

as default risk increases, the credit rating lowers which increases the interest spread

Baa/BBB
- low risk

below Baa/BBB
- have high risk

the difference between the rate of return on a bond and the return on a similar maturity treasury security
- measures the return premium a bond earns to compensate for default risk and liquidity risk
- more comprehensive source of information of the risk of a bond

federal, state and local gov or corporations

households, businesses, governement and foreign investors

markets that trade bonds underwritten by an international syndicate
- offer bonds to investors in different countries
- issue outside of jurisdiction of any single country
- offer bonds in unregistered form

for investors: diversify risk in domestically based portfolio

for bond issuers: more financing options and range of assets, international competition motivates domestic markets

long term bonds that are issued and sold outside the country of the currency in which they are denominated
- pay interest annually using 360 day year
- bearer bonds and traded OTC
- primary market placement by investment banks (issuer chooses currency and the payment + interest will be paid in said currency)

convertible bonds (into equity) or bonds with equity warrants attached

long term bonds issued by firms and governments outside the issuers home country
- denominated in the currency of country where they are issued rather than in domestic currency

government issued foreign currency denominated debt
- issue in foreign currencies, less developed country sovereign debt has lower credit ratings because of increased economic and political risks
- uncollateralized and price reflects credit risk of country issuing the bonds

foreign bond is issued in a country following their currency and regulations by an international issuer

eurobond is underwritten in a currency, then traded outside of where that currency is