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FM6
FM6
FM6
Preview
We examine how capital markets operate, and then
focus our attention on the bonds and the bond
market. Topics include:
Purpose of the Capital Market
Capital Market Participants
Capital Market Trading
Types of Bonds
Treasury Bonds
Municipal Bonds
1
Chapter Preview (cont.)
Corporate Bonds
Financial Guarantees for Bonds
Bond Yield Calculations
Finding the Value of Coupon Bonds
Investing in Bonds
2
Purpose of the Capital Market
3
Capital Market Participants
4
Capital Market Trading
5
Types of Bonds
6
Types of Bonds: Sample Corporate
Bond
The par value, coupon rate are given on the
bond.
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Treasury Bonds
9
Treasury Bond Interest Rates
10
Treasury Bond Interest Rates
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Treasury Bond Interest Rates
Figure 10.2 Interest Rate on Treasury Bonds and the Inflation Rate, 1973–2004
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Treasury Bond Interest Rates:
Bills vs. Bonds
14
Treasury Bonds: Agency Debt
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Municipal Bonds
Issued by local, county, and
state governments.
Used to finance public interest projects.
Tax-free municipal interest rate =
taxable interest rate (1 marginal
tax rate)
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Municipal Bonds: Example
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Municipal Bonds
Two types (p167)
General obligation bonds ( 一般责任债券 ) –do not have
specific assets pledged as security or a specific source of
revenue allocated for their repayment. They are backed
by “the full faith and credit” of the issuers;
Revenue bonds (收益债券) -backed by the cash flow of
a particular revenue-generating project.
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Corporate Bonds
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Corporate Bonds
Most are callable (可赎回) , meaning that the
issuer may redeem ( 赎回 ) the bonds after a specific
date.
The bond indenture ( 债务契约 ) states the lender’s
rights and privileges and the borrower’s obligations.
Degree of risk varies with each bond, even from the
same issue. The required interest rate varies with
level of risk.
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Corporate Bonds
21
Corporate Bonds: Interest Rates
23
Corporate Bonds: Characteristics of
Corporate Bonds
Call Provisions 可赎回条款 (p170)
The right for the issuers to force the holders to sell back.
(usually at the bond’s par price or slightly higher (usu. One year’s interest
cost)
Sinking fund( 偿债基金 ) Issuer pays off a portion of the bond
issue each year.
Interest of the stockholders
Higher yield for the call provision
Conversion
Some debt may be converted to equity
Similar to a stock option, but usually more limited
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Conversion/Equity-related
bonds
Convertible bond: allows the investor to exchange the
bond for a predetermined number of equity shares of
the issuer. Convertibles usually sell at a premium
above the larger of their straight debt value and their
conversion value. See the example in the next slide.
Bonds with equity warrants: can be reviewed as
straight fixed-rate bonds with the addition of a call
option feature. The warrant entitles the bondholder to
purchase a certain number of equity shares in the
issuer at a prestated price over a predetermined
period of time.
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Example
A convertible bond pays interest annually at a coupon
rate of 5% on a par value of $1,000. The bond has 10
years maturity remaining and the discount rate on other-
wise identical non-convertible debt is 5%. The bond is
convertible into shares of common stock at a conversion
price of $25 per share (i.e. the bond is exchangeable for
40 shares). Today’s closing stock price was $31.25.
What is the least that this bond will sell for?
The straight bond value is $1,000 since the coupon rate
equals the yield to maturity. At today’s stock price the
bond is worth $1,250 converted into 40 shares of stock.
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Example
A convertible bond pays interest annually at a coupon rate
of 5% on a par value of $1,000. The bond has 10 years
maturity remaining and the discount rate on other-wise
identical non-convertible debt is 6.5%. The bond is
convertible into shares of common stock at a conversion
price of $25 per share (i.e. the bond is exchangeable for
40 shares). Today’s closing stock price was $20. What is
the least that this bond will sell for?
At today’s stock price the bond is worth $800 converted
into 40 shares of stock.
The straight bond value = $892.17: N=10; I/YR =6.5; PV=
892.17; PMT= $50; FV = 1,000.
$892.17
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Corporate Bonds:
Types of Corporate Bonds
Secured Bonds
Mortgage bonds
Equipment trust certificates
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Corporate Bonds:
Types of Corporate Bonds
Unsecured Bonds
Debentures (信用债券) : are long-term
unsecured bonds that are backed only be the
general creditworthiness of the issuer. Debentures
usually have attached to them indenture.
Subordinated debentures 附属债券 – lower
priority claim
Variable-rate bonds 利率可变债券
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Corporate Bonds:
Characteristics of Corporate
Bonds
Junk Bonds
Debt that is rated below BBB
Often, trusts and insurance companies are not
permitted to invest in junk debt
Michael Milken developed this market in the mid-
1980s, although he was convicted of insider
trading
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Corporate Bonds: Debt Ratings
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Corporate Bonds:
Debt Ratings (cont.)
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Financial Guarantees for Bonds
Some debt issuers purchase financial guarantees to
lower the risk of their debt.
The guarantee provides for timely payment of
interest and principal, and are usually backed by
large insurance companies.
Financial guarantees were developed in 1970s to
insure municipal bonds and expanded to cover
many corporate bonds as well later on.
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Bond Yield Calculations
34
Bond Yield Calculations:
Current Yield(p. 174)
What is the current yield for a bond with a face value
of $1,000, a current price of $921.01, and a coupon
rate of 10.95%?
Answer:
ic = C / P = $109.50 / $921.01 = 11.89%
35
Bond Yield Calculations: Yield on a
Discount Basis (p175)
贴现基础上的收益率
For simplicity, use Yield on a Discount Basis instead
of yield to maturity.
(F-P)/F, one year:360, see p175 formula (2).
What is the discount yield for a one-year bond with a
face value of $1,000, and a current price of $875?
Answer:
idb = [ (F-P) / F ] x [ 360 / days to maturity]
= [ (1000 – 875) / 1000 ] x [360 / 365] = 12.33%
36
Yield on a discount rate vs yield to
maturity
Yield on a discount rate understates the more
accurate “yield to maturity”, and longer the
maturity of the discount bond, the greater this
understatement becomes.
However, a change in the discount yield
always indicates a change in the same
direction for the yield to maturity, i.e., both
negatively related to the price of the bond.
37
Finding the price of semiannual
bonds
Bond pricing is, in theory, no different than
pricing any set of known cash flows – the
current price is the present value of all future
cash flows.
The table on the next slide outlines some of
the terminology unique to debt, which may be
necessary to understand to determine the
cash flows.
38
Finding the Value of Coupon Bonds
39
Finding the Price of Coupon
Bonds
Let’s use a simple example to illustrate the
bond pricing idea.
What is the price of two-year, 10% coupon
bond (semi-annual coupon payments) with a
face value of $1,000 and a required rate of
12%?
40
10.5.6 Finding the Price of
Coupon Bonds
Solution:
1. Identify the cash flows:
• $50 is received every six months in interest
• $1000 is received in two years as principal repayment
41
Investing in Bonds
42
Investing in Bonds
43
10.6.2 Investing in Bonds
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Chapter Summary
45
Chapter Summary (cont.)
46
Chapter Summary (cont.)
47
Chapter Summary (cont.)
48
Group work
Chinese bond market
Please include the following points:
1) Participants
2) Size
3) Instruments
4) Market function
5) Regulation institutions and main regulation aspects
6) Room for development
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