copyright 2015 diane scott docking 1 the bond market my name is bond, corporate bond

Copyright 2015 Diane Scott Docking 1

The Bond Market

My name is Bond,

Corporate Bond.

2Copyright 2015 Diane Scott Docking

Learning Objectives

Describe the major bond markets Know the various types of bonds in each market Know how to read a published Bond Quote Compute the various bond components Describe various types of foreign bonds


3 major Types of Bonds

Types of Bonds Treasury Notes and Bonds Municipal Bonds Corporate Notes and Bonds

The Treasury & Agencies Securities Market



U. S. Treasury Bonds Issued by the U.S. Treasury to finance federal government

expenditures Maturity

> 1 year < 10 Years

> 10

________________ Interest Payments Denominations are in multiples of $ . Active Secondary Market Benchmark Debt Security for Any Maturity Prices are stated as % of par Interest yields are computed on a 365-day basis


Example: T-Bond Quote (at July 22,

2015)

Ask

Maturity Coupon Bid Asked Chg Yield

6/30/2017 2.500 103.4688 103.4844 -0.0156 0.686

Coupon Rate (intervals of 1/8%)

n: Note YTM %Selling at 100+ % of par

% of 100% rounded

http://online.wsj.com/mdc/public/page/2_3020-treasury.html?mod=topnav_2_3021#treasuryA

Change from yesterday’s asked

http://online.wsj.com/mdc/public/page/2_3020-treasury.html?mod=topnav_2_3021#treasuryA


Example: T-Bond Quote (at July 22,

2015)

Ask

Maturity Coupon Bid Asked Chg Yield

6/30/2017 2.500 103.4688 103.4844 -0.0156 0.686

1) Interest received is: 2.50% x $1,000 = $25 annually or $12.50 semi-annually

2) Purchase price: PP = (Asked/100) x Face

PP =103.4844% x $1,000 = $1,034.844

3) YTM = is a good approximation of Ask Yield because Asked Quote is rounded.

FV=1,000

PV=1,034.844

PMT=12.50

N=707 days /365 yrs. x 2 = 1.936986301 x 2 = 3.873972603

CPT i/y= 0.343030248 x 2 = 0.686060497 = 0.686% (good)

0.686%


Treasury Notes and Bonds

“Clean” prices are calculated as:

Vb = the present value of the bond

M = the par value of the bond

INT = annual interest payment (in dollars)

N = the number of years until the bond matures

m = the number of times per year interest is paid

id = interest rate used to discount cash flows on the bond

“Clean” prices are calculated as:

Vb = the present value of the bond

M = the par value of the bond

INT = annual interest payment (in dollars)

N = the number of years until the bond matures

m = the number of times per year interest is paid

id = interest rate used to discount cash flows on the bond

)()( ,/,/ NmmidNmmidb PVIFMPVIFAm

INTV


Treasury Notes and Bonds Accrued interest on T-notes and T-bonds is

calculated as:

The full (or dirty) price of a T-note or T-bond is the sum of the clean price (Vb) and the accrued interest

Accrued interest on T-notes and T-bonds is calculated as:

The full (or dirty) price of a T-note or T-bond is the sum of the clean price (Vb) and the accrued interest

periodcoupon in days ofnumber Actual

paymentcoupon last since days ofnumber Actual

2Face interest Accrued

INT

Last coupon date Settlement date Next coupon date

No count No count Count Count

Days since last coupon payment Days to next coupon payment

Days in coupon period


Example: Accrued Interest

On August 5, 2015 you purchase a $10,000 T-note that matures May 15, 2021. Settlement is August 7, 2015. Coupon rate is 5.875%. Current T-note price quote is 101.3438. The last coupon payment occurred on May 15, 2015 and next coupon will be paid November 15, 2015.

What is the accrued interest due to the seller from the buyer at settlement?

What is the dirty price of this T-note? What is the YTM (based on clean price) of this note?


Solution to Example: Accrued InterestGiven:

Purchase on August 5, 2015

Settlement is August 7, 2015

$10,000 T-note, May 15, 2021, 5.875% coupon

Current T-note price quote is 101.3438

Last coupon payment May 15, 2015

Next coupon payment November 15, 2015.

Current price = 101.3438% x $10,000 = $10,134.38

Last coupon payment on May 15, 2015 occurred 83 days before settlement:

May June July Aug

16 + 30 + 31 + 6 = 83

Next coupon payment on Nov. 15, 2015 occurs 101 days after settlement:

Aug Sept Oct Nov

25 + 30 + 31 + 15 = 101

Days in coupon period from on May 15, 2015 - Nov. 15, 2015:

May June July Aug Sept Oct Nov

16 + 30 + 31 + 31 + 30 + 31 + 15 = 184 days


Solution to Example: Accrued InterestAccrued interest due to the seller from the buyer at settlement?

What is the dirty price of this T-note?Clean Price + Accrued interest = Dirty Price

$10,134.38+ 132.51 = ______________

51.132$184

8375.293$

184

83

2

%875.5$10,000 interest Accrued

periodcoupon in days ofnumber Actual

paymentcoupon last since days ofnumber Actual

2Face interest Accrued

INT


Solution to Example: Accrued InterestWhat is the YTM (based on clean price) of this note?

FV = $10,000

PV = $10,134.38 (clean price)

Pmt = $293.75 ($10,000 x .05875 = 587.50 / 2 = 293.75)

n = 2,108 days (Aug. 8, 2015 – May 15, 2021)

2,108/365 = 5.775342466 years (convert to fraction of years)

5.775342466 x 2 = 11.55068493

i/y = YTM = 2.799729823 x 2 = 5.599459646% = 5.599%


Special Treasury Bonds

Zero-coupon securities are sold with claims on U. S. Treasury bonds held in a trust One security represents the principal payment (np or bp) at

maturity (note principal or bond principal) Other securities represents the interest payments (ci) at

interest paying dates (coupon interest)

http://wsj.com/mdc/public/page/2_3020-tstrips.html

Stripped Treasury Bonds

http://wsj.com/mdc/public/page/2_3020-tstrips.html

Example: Treasury Strips

Friday, July 24, 2015:

Treasury Bond, Stripped Principal

Maturity Bid Asked Chg Asked

yield

2020 Aug 15 91.743 91.789 0.079 1.70

Stripped Coupon Interest


yield

2017 Feb 15 99.079 99.094 0.031 0.59

2020 Aug 15 91.528 91.574 0.002 1.75

1) Verify the Asked Yield on the 2020 Stripped Principal. Assume settlement on Monday, July 27, 2015.

2) Verify the Asked Price on the 2020 Stripped Coupon Interest. Assume settlement on Monday, July 27, 2015.


Bid and AskedQuotes are a % of 100


Verify Asked Yield

Tuesday, July 24, 2015:

Treasury Bond, Stripped Principal


yield

2020 Aug 15 91.743 91.789 0.079 1.70

FV = $1,000

PV = 91.789% x 1,000 = $917.89

Pmt = $0

n = 1,844* days / 365 = 5.052054795 yrs. X 2 = 10.10410959

(need to multiply “n” x 2 since the original T-Bond was a “semi-annual” security.

Compute: i/y = 0.85155452% x 2 = 1.703109041% = 1.70%

(multiply times 2 to annualize the rate).

* Do not count settlement date



Verify Asked Price

Tuesday, July 24, 2015 :

Stripped Coupon Interest


yield

2020 Aug 15 91.528 91.574 0.002 1.75

FV = $1,000

i = 1.75% / 2 = 0.695%

Pmt = $0

n = 1,844* days / 365 = 5.052054795 yrs. X 2 = 10.10410959

(need to multiply “n” x 2 since the original T-Bond was a “semi-annual” security.

i/y = 1.75% / 2 = 0.875% (divide Asked yield by 2).

Compute PV = 915.7367 = 91.574 (good)

* Do not count settlement date



Special Treasury Bonds

TIPS – Treasury Inflation Protection Securities Intended for investors who seek inflation protection with their

investments Coupon rates less than other Treasuries Principal value adjusted for the U.S. inflation rate (CPI) every 6

months Coupon income increases with inflation

http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm

Inflation-Indexed Bonds

http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm


Example: TIPs

An investor purchases $5 million of par value TIPS. The real rate (determined at the auction) is 2.4% (coupon rate). Assume at the end of the first 6 months the CPI-U = 3% (annual rate) and at the end of the second 6 months the CPI-U = 3.8% (annual rate).

Compute the following:1. Inflation adjusted principal at end of first 6 months,

2. Coupon payment made at end of first 6 months,

3. Inflation adjusted principal at end of second 6 months,

4. Coupon payment made at end of second 6 months


Example: TIPs1. Inflation adjusted principal at end of first 6 months:

$5 mill. x (1 + (.03/2)) = $5 mill x 1.015 = _______________

2. Coupon payment made at end of first 6 months:

$5,075,000 x (.024/2) = $5,075,000 x (.012) = _______________

3. Inflation adjusted principal at end of second 6 months:

$5,075,000 mill. x (1 + (.038/2)) = $5,075,000 x 1.019 = _____________

4. Coupon payment made at end of second 6 months:

$5,171,425 x (.024/2) = $5,171,425 x (.012) = _______________


MARKET FOR U.S. TREASURY SECURITIESThe Primary Market Auction cycle

Treasury securities are issued on an auction basis For coupon securities, the government holds

monthly 2-year note and 5-year note auctions, and quarterly auctions for the 10-year note


T-Bond or T-Note Primary Auction

All non-competitive bids accepted.

Specify quantity only.

Maximum bid . Price is the competitive auction

yield price. Investors do not know the

price in advance so they submit check for full par value

After the auction, investor receives check from the Treasury covering the difference between par and the actual price

Specify price (as a yield %) and quantity desired.

Minimum purchase $100 Single price auction used since

1998 Treasury accepts highest bids

prices (lowest bid yields) Maximum amount sold to any

one buyer is 35% of offering amount

http://www.treasurydirect.gov/instit/auctfund/work/work.htm

Noncompetitive Bidding Competitive Bidding




Problem 1: T-Note/Bond AuctionThe Treasury is auctioning off $120 million in 5-year T-notes. The following

bids are received:

Noncompetitive bids: $10 millionCompetitive bids: bid yield

Dealer J $ 1 mill. 4.000%Dealer K $ 5 mill. 4.252% Dealer L $20 mill. 5.000%Dealer M $50 mill. 5.500%Dealer N $ 4 mill. 5.752%Dealer O $10 mill. 6.100%Dealer P $40 mill. 6.100%Dealer Q $60 mill. 6.400%


Solution: T-Note/Bond Auction1. Which dealers will have their bids filled? By how much?

Total auction = $120 million (x 35% = $42 mill. bid limit) - Noncompetitive bids - 10 million Avail. for comp. bids $110 million

Competitive bids:Dealer Bid yld Amt. Bid Amt. Accepted Total Accepted J 4.000% $ 1 mill. $ 1 mill. $ 1 mill. K 4.252% $ 5 mill. $ 5 mill. $ 6 mill. L 5.000% $ 20 mill. $ 20 mill.$ 26 mill. M 5.500% $ 50 mill. $ 42 mill.$ 68 mill. N 5.752% $ 4 mill. $ 4 mill. $ 72 mill. O 6.100% $ 10 mill. $ 7.6 mill. $ 79.6 mill. P 6.100% $ 40 mill. $ 30.4 mill. $110 mill. Q 6.400% $ 60 mill. __-0-___

Total $190 mill. $110 mill.


Solution: T-Note/Bond Auction2. What is the “stopout rate” or “stop yield” or “high

yield”?The highest rate accepted, which is ___________

3. What is the bid-to-cover ratio? = Total $ Bid / Total $ Awarded = $200 mill. / $120 mill = ______


Solution: T-Note/Bond Auction4. What was the price paid by the winning bidders given a coupon

rate of 6%?

FV = $1,000Pmt = 1,000 x 6% = 60/2 = $30 semi-annualN = 5 yrs. X 2 = 10 yrs.ieff = 6.1%/2 = 3.05%

Therefore:PV = 995.745761 = __________per bond

Municipal Bond Market



Municipal Bonds Issued by local, county, and state governments Used to finance public interest projects Types

__________________________________________ issued by a municipality and secured by taxes

_________________________________________ issued by municipality and secured by future user charges

(e.g.: Sewer bonds) _______________________________________

public financing of private business. Tax-free municipal interest rate =

taxable interest rate x (1 - marginal tax rate)im = it (1-T)

NOT Default-Free


Example: Corporate vs. Muni-BondAn investor has the following choices: Aa rated corporate bond yielding 6% Aa rated muni-bond yielding 4%

1) If the investor has a marginal tax rate of 30%, which bond should he/she select? 2) Of 40%?


Example: Corporate vs. Muni-BondAnswer:

1) The after-tax rate on the corporate = 6%(1 - 0.3) = 4.2% > 4% on the muni bond;

ORThe pretax equivalent rate on the muni bond = 4%/(1 - 0.3) = 5.7% < 6% on the corporate

Select the _____________________bond!

2) The after-tax rate on the corporate = 6%(1 - 0.4) = 3.6% < 4% on the muni bond;

ORThe pretax equivalent rate on the muni bond = 4%/(1 - 0.4) = 6.7% > 6% on the corporate

Select the ______________________bond!

Municipal Bond Quote http://finance.yahoo.com/bond screener

http://screener.finance.yahoo.com/bonds.html

Type Issue Price Coupon(%) Maturity YTM(%)CurrentYield(%)

Fitch Ratings Callable

Muni ILLINOIS HSG DEV AUTH HSG BDS 104.38 5.000 1-Jul-2048 4.744 4.790 AA Yes

Muni ILLINOIS FIN AUTH REV REV BDS 111.59 5.000 1-Jul-2046 4.341 4.481 AA Yes

Muni ILLINOIS FIN AUTH REV REV BONDS 109.29 5.500 15-Aug-2043 0.000 5.032 Not Rated No

Muni ILLINOIS HSG DEV AUTH HSG DEV REV BDS

104.49 5.000 1-Jul-2042 4.716 4.785 AA Yes

Muni ILLINOIS FIN AUTH REV REV BDS 121.00 8.000 15-May-2040 6.369 6.612 Not Rated Yes

Muni ILLINOIS FIN AUTH REV REV BDS 102.15 4.500 15-May-2037 4.349 4.405 AA Yes

Muni ILLINOIS FIN AUTH REV REF GO BDS 103.94 5.500 15-May-2037 5.212 5.291 Not Rated Yes


As of July 24, 2015:

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=t&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=i&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=p&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=c&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=m&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=y&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=Y&so=a


http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=r&so=a

http://reports.finance.yahoo.com/z1?b=1&is=illinois&sf=l&so=a

http://reports.finance.yahoo.com/z2?ce=5415152151571766716251&q=b=1&is=illinois&so=d








Municipal Bond Quote http://finance.yahoo.com/bond screener





As of July 24, 2015

ILLINOIS FIN AUTH REV REV BDS As of 24-Jul-2015

OVERVIEW

State: IllinoisPrice: 102.15Coupon (%): 4.500Maturity Date: 15-May-2037Yield to Maturity (%): 4.349Current Yield (%): 4.405Fitch Ratings: AACoupon Payment Frequency: Semi-AnnualFirst Coupon Date: 15-Nov-2007Callable: Yes

BOND PROFILE

Type: MunicipalInsured: YesAlternative Minimum Tax: No

OFFERING INFORMATION

Quantity Available: 5

Minimum Trade Qty: 5

Dated Date: 17-May-2007

Settlement Date: 4-Dec-2014

Origination date was May 17, 2007.A 30-year bond, since maturing May 15, 2037.

The Coupon interest paid Semi-annually

YTM above iscalculated from this date.See next slide.













Example: Municipal Bond Quote

Current purchase price to an investor is: (Price / 100) x Face = (102.15 / 100) x $1000 = $1,021.50

Current Yield = coupon / price = 4.500/102.15 = .044052863 = 4.405%

Settlement date is Dec. 4, 2014 (see previous slide):Yield% = YTM of 4.349% is computed as follows:

FV=1,000PV=1,021.50Pmt=(.045 x $1000) = $45/ 2 = $22.50 semi-annually N= 8,192 days /365 = 22.44383562 yrs. x 2 = 44.88767123therefore i=2.174503 x 2 = 4.349006% = 4.349% (good)




As of July 24, 2015::













The Bond Market

My name is Bond,

Corporate Bond.

Sample Corporate Bond



Corporate Bonds Face value of $1,000 Usually pay interest semi-annually Most have maturities between 10-30 years

If less than 10 years, referred to as Corp. Notes Secured by Collateral

Assets – real and financial ______________ - unsecured bonds.

Banks may own corporate bonds BAA grade (investment grade) or better

Thin market


Example: Corporate Bond Quote http://finance.yahoo.com/bonds; http://reports.finance.yahoo.com/z1?is=citigroup; http://finra-markets.morningstar.com/BondCenter/Default.jsphttp://screener.finance.yahoo.com/bonds.html

Issuer Name Symbol Coupon Maturity Moody’s/S&P/Fitch

Price YTM(%) Current Yield (%)

Callable

Citigroup Inc C.ALY 4.500% Jan. 14,2022

Baa2/A-/A 111.05 2.777 4.052 No

Current purchase price to an investor is: (Price / 100) x Face = (111.05 / 100) x $1000 = $1,110.50

Current Yield = coupon / price = 4.500/111.05 = .0405223 = 4.052%

Settlement date is Dec. 4, 2014 (see next slide):Yield% = YTM of 2.777% is computed as follows:

FV=1000PV=1,110.50Pmt=(.045 x $1000) = $45/ 2 = $22.50 semi-annually

N= 2,596 days/365 = 7.112328767 yrs. x 2 = 14.22465753therefore i=1.388573639 x 2 = 2.77714728% = 2.777% (good)

As of Tuesday July 28, 2015:

http://finance.yahoo.com/bonds

http://finance.yahoo.com/bonds

http://reports.finance.yahoo.com/z1?is=citigroup

http://reports.finance.yahoo.com/z1?is=citigroup

http://finra-markets.morningstar.com/BondCenter/Default.jsp

http://finra-markets.morningstar.com/BondCenter/Default.jsp



Example: Corporate Bond Quote


The Coupon interest paid Semi-annually

Bond was originallyissued Nov. 1, 2011.

CITIGROUP INC As of 28-Jul-2015

OVERVIEW Price: 111.05

Coupon (%): 4.500

Maturity Date: 14-Jan-2022

Yield to Maturity (%): 2.777

Current Yield (%): 4.052

Fitch Ratings: A

Coupon Payment Frequency: Semi-Annual

First Coupon Date: 14-Jul-2012

Type: Corporate

Callable: No

OFFERING INFORMATION Quantity Available: 18

Minimum Trade Qty: 1

Dated Date: 1-Nov-2011

Settlement Date: 4-Dec-2014

YTM on previous slide isCalculated from this date.


Corporate Bond Terminology Indenture Trustee Sinking Fund Provision Protective/Restrictive Covenants Call provisions


Corporate Bonds - Types Junk bonds vs. Angel bonds Bearer bonds vs. Registered bonds Term bonds vs. Serial bonds Mortgage bonds Debentures and Subordinated debentures

Callable bonds vs. Putable bonds Convertible bonds vs. Stock Warrants Eurobonds

Eurodollar bonds


Example: Convertible BondsTitan Corp. has a convertible bond issue outstanding.

Each $1,000 face value of bond can be converted into common shares at a conversion rate 285.71. Titan’s common stock is currently trading at $9.375 per share. The bonds are trading at 267.875% of par.

1. What is the conversion price per share?

2. What is the conversion value of each bond?

3. Is it profitable for bond holders to convert their bonds to stock?


Solution to Example: Convertible BondsGiven: Bond price = $2,678.75 per $1,000 face.

Stock price = $9.375 / sh.

Conversion rate = 285.71

1. What is the conversion price per share?

$1,000 / 285.71 = ____________________

2. What is the conversion value of each bond?

CV = stock price x conv.rate = $9.375 x 285.71 = ___________

3. Is it profitable for bond holders to convert their bonds to stock? ______, CV Bond price

Corporate Bonds: Debt Ratings



Foreign Bonds Foreign bonds

bonds issued in the national market by a nonresident borrower and denominated in the national currency.

bonds issued and sold in the U.S. by foreign firms and denominated in dollars

bonds issued and sold in Japan by foreign firms and denominated in yen

bonds issued and sold in the UK by foreign firms and denominated in British sterling pounds


Foreign Bonds

bonds issued and sold in Canada by foreign firms and denominated in Canadian dollars

bonds issued and sold in Australia by foreign firms and denominated in the Australian dollar

bonds issued and sold in an Asian nation (other than Japan or China) by foreign firms and denominated in that country’s currency

E.g.: bonds issued and sold in Malasia by foreign firms and denominated in Malaysian Ringgit


Foreign Bonds

bonds issued and sold in New Zealand by foreign firms and denominated in New Zealand dollars

bonds issued and sold in the Netherlands by

foreign firms and denominated in Euros

bonds issued and sold in Spain by foreign firms and denominated in Euros

bonds issued and sold in Korea by foreign

firms and denominated in wons


Foreign Bonds

bonds issued and sold in Turkey by foreign firms and denominated in the Turkish lira

bonds issued and sold in China by foreign

firms and denominated in yuans (aka: Renminbi (RMB))

bonds issued and sold in Tawain by foreign

firms and denominated in Taiwan Dollar

copyright 2015 diane scott docking 1 the bond market my name is bond, corporate bond

Documents

bond slide

tbond quote

bond int

corporate bond

treasury bonds

bonds accrued

bond clean prices

published bond quote