stock market analysis and personal finance mr. bernstein bonds (aka fixed income) pp 306-325 march...
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Stock Market Analysis and Personal Finance
Mr. Bernstein
Bonds (aka Fixed Income)pp 306-325
March 11, 2015
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Stock Market Analysis & Personal Finance Mr. Bernstein
BondsBond is a contract to repay a loan on a given maturity date.Face value = final payout ( ~ loan amount)Bonds are traded Over the Counter (OTC) – there is no meaningful exchange
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Stock Market Analysis & Personal Finance Mr. Bernstein
Types of BondsDebentures, or unsecured bonds, are backed only by the
reputation of the issuer. Most corporate bonds are debentures
Mortgage bonds are backed by a lien on a home or other real estate
Secured bonds are backed by a lien on collateralConvertible bonds can be converted into stockBond contracts may have other provisions called covenantsJunior debt is subordinated to senior debtFloaters have coupons which adjust with interest rates
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Stock Market Analysis & Personal Finance Mr. Bernstein
Why Buy Bonds?Interest IncomeCapital Gains
When interest rates fall, bond prices riseWhen interest rates rise, bond prices fall
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Stock Market Analysis & Personal Finance Mr. Bernstein
Why Buy Bonds?Interest Income
Current Yield = Annual Income / PriceCapital Gains
When interest rates fall, bond prices riseWhen interest rates rise, bond prices fall
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Stock Market Analysis & Personal Finance Mr. Bernstein
Why Buy Bonds?Interest IncomeCapital Gains
When interest rates fall, bond prices riseWhen interest rates rise, bond prices fall
Example: Exxon 5% due 4/5/2023…at 5% yield bond price =100. At 4% yield bond price = 110. Why? 5% coupon is reduced by capital loss of 10% over ten years, or 1% per year.
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Stock Market Analysis & Personal Finance Mr. Bernstein
Why Buy Bonds?Yield to Maturity =
Coupon Income + (Pymt at maturity - Price Paid)Price Paid
Yield to Maturity is the primary measure of a bond’s value
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Stock Market Analysis & Personal Finance Mr. Bernstein
Bond RatingsRatings Agencies rate bonds based on the
likelihood of repayment at maturityMoody’s, Standard & Poor’s and Fitch are the
three major Rating AgenciesBonds are rated from D to AAABBB and above are “Investment Grade”BB and below are “High Yield” or “Junk” bonds
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Stock Market Analysis & Personal Finance Mr. Bernstein
Bond RatingsRatings Agencies are paid by issuers of new
bonds, i.e. corporations, finance companiesIs this a conflict of interest?Can investors rely on ratings?
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Stock Market Analysis & Personal Finance Mr. Bernstein
Bond PricingInvestors generally demand more yield for:
Higher perceived risk of repaymentHigher perceived risk of inflationLonger maturities
Relative value is determined by the difference between the Yield to Maturity and the yield on a comparable maturity US Treasury bond (the Spread to Treasuries)
Corporate Bond Price Information (FINRA)http://finra-markets.morningstar.com/MarketData/Default.jsp
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Stock Market Analysis & Personal Finance Mr. Bernstein
Bond PricingTo receive a higher yield to maturity, what
component of the Yield to Maturity formula must change?
Yield to Maturity = Coupon Income + (Pymt at maturity - Price Paid)
Price Paid
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