This presentation is an adaptation of the Powerpoint made by Rohan Monga, Natalie Schmid and Juan Munoz for Eng 90 2003
BOND
The name’s Bond, Junk Bond.
Definition
A bond is a borrowing arrangement through which the borrower (or seller of a bond) issues or sells an IOU document to the investor (or buyer of the bond).
Debt Securities with Fixed Income.
Why Issue Debt
Firm wants to raise capital
Does not want to dilute ownership
Can earn more money on the use of the funds in the business than the cost of interest on the debt.
TERM
TERM
The length of time until the principal amount of a bond must be repaid.
Maturity Date: The end of the life of a security. The day on which the principal or amount must be repaid.
Face/Par value
What the Bond reads and what the investor receives if they hold the bond to its maturity.
Face Value of most treasuries is $1000.
Why invest in a bond?
To distribute risk across a diversity of investments holdings.
Investors want a steady reliable interest payment and return of their full capital or investment at the end of the term of the bond
KEY TERMS
KEY TERMS
Coupon Payments: amount of interest paid, usually 2 times a year.
Price of Bond: The amount someone will pay for that bond in the open market.
Ratings – Bond Risk
An evaluation of the possibility of default by a bond issuer. It is based on an analysis of the issuer's financial condition and profit potential. Bond rating services are provided by, among others, Standard & Poor's, Moody's Investors Service, and Fitch Investors Service.
Bond ratings start at AAA (being the highest investment quality) and usually end at D (in payment default).
Types of Bonds
Municipal
Treasuries
Zero-Coupon
Junk / Speculative-grade
International
Innovation in Bond Market!
Issuers constantly develop innovative bonds with unusual features, displaying the flexibility of bond design
Listings of Bonds
In WALL STREET JOURNAL
Valuation of a Bond- Terms
There are many factors that influence Bond pricing: Interest or coupon rate; Ratings of a Company’s ability or certainty to make repayment, time to maturity.
But fundamentally, valuation depends on the interest rate on the face of the bond in comparison to the interest rate for a comparable bond just being issued
Example of Valuation of Bonds
Take a U.S. Treasury bond with a $1,000. face value. The question is its value today- what would you pay for it now??
First look at its due date: It was issued on March 1, 1999 and will mature (come due) in 30 years. Next look at its coupon.
The coupon or interest rate payable on the bond as of the date of issue is 8% per annum paid ½ on Sept 1 and ½ March 1
Thus , twice a year you receive 40.00
Now compare this to a new bond offering:
Bond valuation
New Bond of 1,000.00 just issued is due in 2029 or 25 years.
It’s coupon or interest rate is 4%
You get $20.00 two times a year or $40.
Since the term is still fairly far off, the value of the older bond will be priced for the most part based on its yield or coupon in relation to what can be had today less a discount of its face value.
The old bond yields 80.00 per year or twice as much as this bond. Therefore its value is twice as much since you would have to buy 2,000.00 worth of bonds now to get the same return.
Formula
Formula
Face Value of Old Bond: 8% of $1,000 = $80.00 per annum
New Bond: 4% of 1,000.00= 40.00
.04 X = 80.00
X = 2,000.00
Value of old bond today is 2000.
When interest rates rise the value of the bond goes down.
Value of bonds move in the opposite direction of interest rates.
