BOND/DEBT MARKET

CCIG

Size of Market

The global bond market is about $82 trillion.  The global stock market hovers around $40-$50 trillion.  So, on pure size alone, the bond market is almost twice the size of the stock market.  That’s a substantial difference. 

Nearly all of the average daily trading volume in the U.S. bond market takes place between broker-dealers and large institutions in an OTC market 

Graphical Depiction

A debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as an issuer

In return, the issuer provides you with a bond in which it promises to pay a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures, or comes due.

What Are Bonds?

Predictable income stream.

Portfolio diversification.

Great investment choice for IRA’s and 401k’s (retirement planning).

Either saving for your children’s college education or for a new home, fixed income can do the magic.

Why Invest in Bonds?

Characteristics of Bond

Risk is proportional to return.

Safer investments offer lower returns. Hence Treasury rate is the lowest bond rate you can obtain on the bond market.

Key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status.

Assessing Risk

Bond Price

C = coupon payment n = number of payments i = interest rate, or required yield M = value at maturity, or par value  

Interest that can be fixed, floating or payable at maturity. Fixed rate bonds carry any interest rate that is established

when the bonds are issued (expressed as a percentage of the face amount) with semiannual interest payments

Floating rate bonds carries a rate which is reset periodically in line with interest rates on Treasury bills, the London Interbank Offered Rate (LIBOR), or some other benchmark interest-rate index.

Zero coupon bonds: Investor receives one payment at maturity that is equal to the purchase price (principal) plus the total interest earned.

Bond Interest Rate

The longer a bond's term, the more its price may be affected by interest rate fluctuations. Hence, investors expect to be compensated for taking that extra risk.

This relationship can be best demonstrated by drawing a line between the yields available on similar bonds of different maturities, from shortest to longest. Such a line is called a yield curve.

Time to Bond Maturity

Yield curve

Who issues bonds?

Government Treasury STRIPS TIPS

Municipal (Tax Free Status) Corporations

Rating Agencies

Moody S&P Fitch

3 Rates – Do Not Confuse

YTM – Yield to Maturity (IRR) Coupon Rate Current Yield

Risk

Interest Rate Risk Longevity Risk Inflation Risk

Application

Tax deductible of interest expenses for businesses

No control over voting rights Negative impact on cash flow

Example

Option 1 Option 2

Stock Bonds

Income before Interest and Taxes (EBIT) $ 40,000.00 $ 40,000.00

Interest (8% * 100,000) $ - $ 8,000.00

Income before taxes $ 40,000.00 $ 32,000.00

Income Tax (35%) $ 14,000.00 $ 11,200.00

Net Income $ 26,000.00 $ 20,800.00

Shareholder's Equity $ 200,000.00 $ 100,000.00

ROE 13% 20.80%

Corporate Bonds

Quantitative Easing

Nov 2010: Government to spend $900 over the next 8 month to buy treasuries

91% bought on the shorter end of the spectrum

Combat the snail paced growth Problems:

Inflation is low - possibly cause deflation since

QE1 – 2008 - $600 billion -> $1.8 trillion

Individual Bonds Most individual bonds are bought and sold in the

over-the-counter (OTC) market, although some corporate bonds are also listed on the New York Stock Exchange.

The OTC market comprises securities firms and banks that trade bonds; brokers or agents, who buy and sell bonds on behalf of customers in response to specific requests; and dealers, who keep an inventory of bonds to buy and sell. 

How To Invest (1)

Bond Funds Bond funds, like stock funds, offer professional selection

and management of a portfolio of bonds for a fee. Through a bond fund, an investor can diversify risks across

a broad range of issues and opt for a number of other conveniences, such as the option of having interest payments either reinvested or distributed periodically.

Some funds are designed to follow a market, in general or a specified index of bonds. These are often referred to as index or passive funds.

Other funds are actively managed according to a stated objective, with bonds purchased and sold at the discretion of a fund manager.

How To Invest (2)

Active vs. Passive. Diversification: achieved in any number of ways.

1/ Bond Type: mix of high-yield and investment-grade bonds. 2/ Laddering: purchase securities of various maturities to mitigate

interest rate risks.

E.g. you might invest equal amounts in bonds maturing in 2, 4, 6, 8 and ten years. In two years, when the first bonds mature, you would reinvest the money in a 10-year maturity, maintaining the ladder.

Bond Swap: The sale of a block of bond swaps and the purchase of another block of

similar market value. Swaps may be made to achieve many goals, including establishing a tax loss, upgrading credit quality, extending or shortening maturity, etc.

The most common swap is done to achieve tax savings by converting a paper loss into an actual loss that could partially or fully offset other capital gains or income.

Investment Strategy Considerations

Bond calculators : www.investinginbondseurope.org

Bonds investing:www.investinginbonds.com

Reference websites