Bond Features and Markets - PowerPoint Presentation

Slide1

Bond Features and MarketsSlide2

A Bond Issued by Macy’s

Term

Amount of issue

$550

million

Date of issue

01/15/2012

Maturity

01/15/2022

Face value

$2,000

Annual coupon

3.875

Offer price (%)

99.189

Coupon payment dates

01/15, 07/15

Security

None

Sinking fund

None

Call provision

At any time

Call price

Treasure rate plus 0.35%

Rating

Moody’s Baa3,

S&P BBB-Slide3

A Bond Issued by Macy’s

Annual coupon: 3.875

The coupon rate

is 3.875%

Each bondholder will receive

per bond per yearOffer price: 99.189The price offered to the public is Coupon payment dates: 01/15, 07/15This is semiannual coupon bond$38.75 (=$77.5/2) is paid to investor on Jan, 15 and July, 15

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Security

T

he issuer may pledge some of their assets for the bond. With these assets, the bondholders are secured when the company cannot repay its obligations

Collateral: Financial securities that are pledged as security for payment of bond

Mortgage: Real property (real estate, like

land or buildings)Debentures: Unsecured bond for which no specific pledge of property is madeNotes: Unsecured debt with original maturity less than 10 yearMacy’s bond Security: NoneThe bonds are not secured by specified assetsSlide5

Sinking Fund

Usually, the bondholders receive the face value at maturity, but sometimes they may be repaid in part or in entirely before maturity

Early repayment is often handled through a sinking fund

A sinking fund is an account managed by the bond trustee for the purpose of repaying the bond

The company makes annual payment to the trustee

The trustee uses the funds to retire a portion of the bonds: Buying up some of the bonds or calling in a fraction of the outstanding bondsMacy’s bond Sinking Fund: NoneThe bonds have no sinking fundSlide6

Call Provision

A call provision allows the company to repurchase part or all of the bond issue at

stated price

over

specified time

Deferred call provision: the company can be prohibited from calling its bonds for the first part of a bond’s life (say the first 10 years)During this period of prohibition, the bond is said to be call protectedMacy’s bond Call Provision: At any timeThe bonds can be called at any time before maturityThe bond do not have deferred callSlide7

Call Price

S

tated price in call provision

P

rice the company used to call the bonds from the market

Call price > face value, why?The company would like to call the bond when the market interest rate is lower than the bond’s couponWhen the company calls the bond, it hurts bondholders’ benefit, so the bond has to be called at a price greater than face value Call premium = Call price – face valueMacy’s Call Price: Treasury rate plus 0.35%The discount rate (YTM) used to compute Macy’s call price is treasury rate at calling time + 0.35%Slide8

Protective Covenants

Negative covenants

Limit certain actions a company might otherwise wish to take during the term of the loan

Example: The firm cannot pledge any assets to other lenders

Positive covenants

Specify an action that the company agree to take or a condition the company must abide byExample: The firm must maintain any collateral or security in good conditionSlide9

Bond Indenture (

Deed of Trust)

Contract between issuing company and

bondholders

Includes

:Basic terms of the bondsTotal amount of bonds issuedSecured versus UnsecuredSinking fundCall provisions

Deferred call

Call premium

Details of protective covenantsSlide10

Bond Ratings – Investment-Quality

Measure bond

default

risk

High GradeMoody’s Aaa and S&P AAA: Capacity to pay is extremely strongMoody’s Aa and S&P AA: Capacity to pay is very strongMedium GradeMoody’s A and S&P A: Capacity to pay is strong, but more susceptible to changes in circumstances

Moody’s Baa and S&P

BBB: Capacity

to pay is adequate, adverse conditions will have more impact on the firm’s ability to

pay

Macy’s bond Credit Rating: Baa3 BBB-

This bond has moderate credit risk at the bottom of investment gradeSlide11

Bond Ratings – Low Quality

Low

and Very Low Grade

Moody’s:

Ba, B,

Caa, Ca, CS&P: BB, B, CCC, CC, CConsidered speculative with respect to capacity to pay. The “BB” and “Ba” ratings are the lowest degree of speculationAlthough such bond is likely to have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditionsDefaultMoody’s D and S&P D – in default with principal and interest in arrearsSlide12

Primary vs. Secondary Market

Primary

Market

Original sale of securities by governments or corporations

Public offerings

Private placementsSecondary MarketSecurities are bought and sold after the original saleProvide the means for transferring ownership of corporate securitiesDealer markets and auction marketsSlide13

Dealer and Dealer Market

Dealers

Maintains

an

inventory

Buy and sell for themselves, at their own riskUsed car dealer; local college bookstoreDealer MarketMost of buying and selling is done by dealersNo central locationMost trading in debt securities takes place over the counter (OTC) in old daysMany dealers are connected electronically nowSlide14

Bond Market

Dealer market

Extremely large number of bond

issues

A corporation typically has only 1 common stock, but could have a dozen or more bond issues

Federal, state, and local governments can have a wide variety of bonds outstandingLittle or no transparencyGetting up-to-date prices difficult, particularly on small company issuesLittle centralized reporting of transactions, which are privately negotiated between partiesSlide15

Corporate Bond Quotations

Corporate bond dealers are now required to report trade information through Trade Reporting and Compliance Engine (TRACE)

One site that provides bond information is

www.finra.org/industry/trace/corporate-bond-data

Database that

provides bond information is BloombergSlide16

Treasury QuotationsSlide17

Treasury Quotations

This

bond

will mature

on May 15, 2030 The coupon rate on this bond is 6.250%If this bond par value is $1,000, investors can receive

from

selling

it to dealers

If this bond par value is $1,000, investors must pay

to

buy

it from deals

Maturity

Coupon

Bid

Asked

Chg

Asked Yield

5/15/2030

6.250

150.7188

150.7500

.8906

2.713Slide18

Treasury Quotations

Ask price goes up by 0.8906% since the previous day

Two bond prices correspond to two YTM.

Asked Yield

is the YTM (=2.713%) used to compute

Asked Price (=$1,507.5)

Maturity

Coupon

Bid

Asked

Chg

Asked Yield

5/15/2030

6.250

150.7188

150.7500

.8906

2.713Slide19

Problem 6-13 Use Treasury Quotes

Locate the Treasury issue in

Figure 6.3

maturing in August 2021. Assume a par value of $1,000. What is its coupon rate? What is its bid price in dollars? What was the

previous day’s

asked price in dollars?MaturityCoupon Bid

Asked

Chg

Asked Yield

8/15/2021

8.125

155.1094

155.1563

.7969

2.713Slide20

Clean Price

You have decided to purchase an bond with a face value of $1,000 and a market quote of 105

The market quoted bond price (in dollars) is

clean price

Clean price:

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Dirty (Invoice) Price

This bond pays a 12% semiannual coupon on 6/30 and 12/31 of each year

If you are going to purchase the bond on 5/31/201

7

, the price you need to pay is clean price plus

accrued interests. We call this price dirty (invoice) priceOn 6/30/2017, coupon will be paid to you (current owner). The previous bond owner will ask you a fraction of this coupon on the date you buy the bond. How much will he ask for?

Accrued interests: $50

Dirty price:

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Problem 6-21 Accrued Interest

You purchase a bond with an invoice price of $1,095. The bond has a coupon rate of

9.9%,

semiannual coupons, and there are two months to the next coupon date

.

What is the clean price of the bond?Slide23

Problem 6-22 Accrued Interest

You purchase a bond with a coupon rate of 9 percent, semiannual coupons, and a clean price of $840. If the next coupon payment is due in three months, what is the invoice price?Slide24

Real and Nominal Rates

Nominal rate on an investment is the % change in the number of $

Real

rate on an investment is

the %

change in purchasing powerDifference between nominal and real rate is inflationSlide25

Example: Pizzas

Pizzas cost $5 per piece today and will cost $5.25 in a year

$100 buys 20 pieces of

pizza today

If the interest rate is 15.5%, we can

withdraw $115.50 in a year after depositing $100 today $115.50 in a year can buy 22 pieces of pizzaOur buying power goes up by 10% , which is the real interest rateInflation is 5% per yearSlide26

Fisher Effect

Fisher effect is the relationship between

real rates, nominal

rates, and inflation

: Nominal rate

: Real

rate

: Inflation

rate

Approximation:

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Problem 6-11 Nominal and Real Returns

An investment offers a total return of 14 percent over the coming year. Bill Bernanke thinks the total real return on this investment will be only 8.1 percent. What does Bill believe the inflation rate will be over the next year?Slide28

Term Structure of Interest Rates

The graphical representation of the relationship between YTM and maturity of

default-free

,

pure discount

bonds is called the time structure of interest ratesTells the pure time value of money for different length of timeThree components determine the shape of term structureReal rate of interestInflation Interest rate riskSlide29

Normal Case: Upward-SlopingSlide30

Inverted Case: Downward-Sloping Slide31

Treasury Yield CurveSlide32

Risk and Reward for holding Bonds

Anything

else that affects the risk of the cash flows

(bond payments) to

the bondholders will affect the

bond yield to maturity (YTM)Bond YTM is the return required in the market to compensate those risks of investing in bond