Bond Market

Preview
“ Equity is for Wealth creation and Debt is for wealth
Protection”
We focus on longer-term securities: bonds. Bonds are
like money market instruments, but they have maturities
that exceed one year. These include Treasury bonds,
corporate bonds and mortgages
Industry Overview
15.401

Fixed-income securities are financial claims with promised cashflows of

known fixed amount paid at fixed dates.
Classification of Fixed-Income Securities:
 Treasury Securities
– U.S. Treasury securities (bills, notes, bonds)
– Bunds, JGBs, U.K. Gilts
– ….
 Federal Agency Securities/RBI
– Securities issued by federal agencies
– TBILL /RBI g secs

 Corporate Securities
– Commercial paper
– Medium-term notes (MTNs)
– Corporate bonds
– ….
 Municipal Securities
 Mortgage-Backed Securities
 Derivatives (CDO’s, CDS’s, etc.)
Industry
Overview
15.401

U.S. Bond Market Debt 2006 ($Billions)

Asset-Backed, Municipal,
2,016.70, 8% 2,337.50, 9%
Money Treasury,
Markets, 4,283.80, 16%
3,818.90, 14%

Federal
Agency,
2,665.20, 10%

Mortgage-
Corporate, Related,
5,209.70, 19% 6,400.40, 24%

Slide 4
Industry
Overview
15.401

Courtesy of SIFMA. Used with permission. The Securities Industry and Financial Markets Association (SIFMA) prepared this
material for informational purposes only. SIFMA obtained this information from multiple sources believed to be reliable as of the date
of publication; SIFMA, however, makes no representations as to the accuracy or completeness of such third party information.
SIFMA has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any
such information becomes outdated, inaccurate, or incomplete.

Slide 5
Industry
Overview
15.401

U.S. Bond Market Issuance 2006 ($Billions)

M unicipal,
Asset-Backed,
265.3, 6%
674.6, 16%
Treasury,
Federal 599.8, 14%
Agency, 546.9,
13%

Corporate, Mortgage-
748.7, Related,
17% 1,475.30, 34%

Slide 6
Industry
Overview
15.401

Courtesy of SIFMA.Used with permission. The Securities Industry and Financial Markets Association (SIFMA) prepared this material
for informational purposes only. SIFMA obtained this information from multiple sources believed to be reliable as of the date of
publication; SIFMA, however, makes no representations as to the accuracy or completeness of such third party information. SIFMA
has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such
information becomes outdated, inaccurate, or incomplete

Slide 7
Industry
Overview
15.401

Courtesy of SIFMA. Used with permission. The Securities Industry and Financial Markets Association (SIFMA) prepared this
material for informational purposes only. SIFMA obtained this information from multiple sources believed to be reliable as of the date
of publication; SIFMA, however, makes no representations as to the accuracy or completeness of such third party information.
SIFMA has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any
such information becomes outdated, inaccurate, or incomplete.

Slide 8
Industry
Overview
15.401

Fixed-Income Market Participants

Investors:
Issuers:

Intermediaries:  Governments
Governments
 Primary Dealers  Pension Funds
 Corporations
 Other Dealers  Insurance Companies
 Commercial Banks
 Investment Banks  Commercial Banks
 States
 Credit-rating Agencies  Mutual Funds
 Municipalities
 Credit Enhancers  Hedge Funds
 SPVs
 Liquidity Enhancers  Foreign Institutions
 Foreign Institutions
 Individuals

Slide 9
Types of Bonds:
Sample Corporate Bond
Types of Bonds:
Sample Corporate Bond
Figure 12.1 Hamilton/BP Corporate Bond
Bonds
Terminology
• Bond - Security that obligates the issuer to make
specified payments to the bondholder.
• Face value (par value or principal value) - Payment
at the maturity of the bond.
• Coupon - The interest payments made to the
bondholder.
• Coupon rate - Annual interest payment, as a
percentage of face value.
Bonds
WARNING
The coupon rate IS NOT the discount rate used in
the present value calculations.
• The coupon rate merely tells us what cash flow
the bond will produce
• Since the coupon rate is listed as a %, this
misconception is quite common
Valuing a Bond
The price of a bond is the present value of all
cash flows generated by the bond (i.e.
coupons and face value) discounted at the
required rate of return

Note: “cpn is for coupon payments”

Valuing a Bond
Example - France
In October 2014 you purchase 100 euros of bonds in
France which pay a 4.25% coupon every year. If the
bond matures in 2018 and the YTM is 0.15%, what is
the value of the bond?
Valuing a Bond as an Annuity
PV(bond) = PV(annuity of coupons) + PV(principal)
Valuing a Bond
Example
What is the price of a 7.25 % annual coupon bond, with a
$1,000 face value, which matures in 3 years? Assume a
required return of 0.35%.
Valuing a Bond
Example - USA
In November 2014 you purchase a 3 year US
Government bond. The bond has an annual coupon
rate of 4.25%, paid semi-annually. If investors demand
a 0.965% semiannual return, what is the price of the
bond?