Investment Analysis and Portfolio
Management
11
First Canadian Edition
By Reilly, Brown, Hedges, Chang
Chapter 11
Bond Fundamentals
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Basic Features of a Bond
Global Bond Market Structure
Types of Bond Issues
Obtaining Information on Bond Prices
Copyright © 2010 by Nelson Education Ltd.
11-2
The Basic Features of a Bond
• Bonds as fixed income securities
• Pay a fixed amount of interest periodically
to the holder of record
• Repay a fixed amount of principal at the
date of maturity
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11-3
The Basic Features of a Bond
• Bond market is divided by maturity
• Money Market: Short-term issues that
mature within one year
• Notes: Intermediate-term issues that
mature between one and ten years
• Bonds: Long-term obligations with
maturity greater than ten years
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11-4
Bond Characteristics
• Intrinsic Features
• Coupon:
• Determine the periodic interest income
• Term to maturity:
• Term bond or a serial bond
• Principal value:
• Different from market value and the common
principal or par value is $1,000
• Type of ownership:
• Bearer vs. registered bonds
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11-5
Bond Characteristics
• Types of Issues
• Secured (senior) bonds
• Unsecured bonds (debentures)
• Subordinated (junior) debentures
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11-6
Bond Characteristics
• Indenture provisions
• The indenture is the contract between the issuer
and the bondholder specifying the issuer’s legal
requirements
• Features affecting a bond’s maturity
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Callable (call premium)
Noncallable
Deferred call
Nonrefunding provision
Sinking fund
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11-7
Rates of Return on Bonds
Holding Period Return
where:
HPRi,t = the holding period return for bond i during period t
Pi,t+1 = the market price of bond i at the end of period t
Pi,t = the market price of bond i at the beginning of period t
Inti,t = the interest payments on bond i during period t
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11-8
Rates of Return on Bonds
Holding Period Yield
Copyright © 2010 by Nelson Education Ltd.
11-9
The Global Bond Market Structure
• The market for fixed-income securities
is substantially larger than the listed
equity exchanges (NYSE, TSE, LSE)
because corporations tend to issue
bonds rather than common stock
• In 2007, 30% of new security issues in
Canada were equity (common and
preferred)
Copyright © 2010 by Nelson Education Ltd.
11-10
The Global Bond Market Structure
• Bond Ratings
• Most corporate and municipal bonds are rated by
one or more of the rating agencies
• The exceptions are very small issues and bonds
from certain industries, such as bank issues.
These are known as non-rated bonds
• Two major rating agencies
• Dominion Bond Rating Service (DBRS)
• Standard and Poor’s Rating Direct Canada
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11-11
The Global Bond Market Structure:
Bond Ratings
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11-12
Types of Bond Issues
• Domestic Government Bonds
• Canada
• T-bills, notes, bonds
• Real Return Bonds (RRBs)
• CPI indexed bonds
• Canada Savings Bonds (CSBs)
• Japan
• Medium term, long term, super long term
• United Kingdom
• Short gilts, medium gilts, long gilts
• Eurozone
• Government bonds
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11-13
Types of Bond Issues
• Government Agency Issues
• United States
• Not direct issues, but backed by “full faith and
credit” of the U.S. government
• GNMA pass-through certificates
• Japan
• Account for about 7% of the total Japanese yen
bond market
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11-14
Types of Bond Issues
• Municipal Bonds
• General obligation (GO) bonds
• Revenue bonds
• Interest payments are exempt from federal
income tax
• Convert the tax-free yield of a municipal bond
selling close to par to an equivalent taxable yield
(ETY)
i
ETY 
ETY
(1 - T )
where: i = coupon rate of the municipal obligations
T = marginal tax rate of the investor
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11-15
Types of Bond Issues
• Municipal Bond Insurance
• Significant feature of U.S. municipal bond
market is municipal bond insurance
• Bond insured against default risk
• Insurance is irrevocable for the life of the
issue
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11-16
Types of Bond Issues
• Corporate Bonds
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Mortgage bonds
Equipment trust certificates
Collateral Trust Bonds
Collateralized mortgage obligations (CMOs)
Asset-backed securities (ABSs)
Certificates for automobile receivables (CARs)
Credit card receivables
Variable rate notes
Zero coupon and deep discount bonds
High-yield bonds
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11-17
Corporate Bonds
• High-Yield Bonds
• Also known as speculative
bonds and junk bonds
• Based on specification that
bonds rated below BBB
make up high-yield market,
that is, non-investment
grade bonds
• High-yield bond market
exploded in size and activity
beginning in the early 1980s
• Major owners of high-yield
bonds have been mutual
funds, insurance companies,
and pension funds
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11-18
Corporate Bonds
• Japanese Corporate Bond Market
• Bonds issued by industrial firms or utilities
• Minimum issuing requirements are specified by
the Ministry of Finance
• Bonds issued by banks to finance loans to
corporation
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Commercial banks
Long-term credit banks
Mutual loan and savings banks
Specialized financial institutions
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11-19
Corporate Bonds
• Pound Sterling Corporate Bond Market
• Three Forms
• Debentures
• Unsecured loans
• Convertible bonds
• Maturity structure is fairly wide
• Coupon structure is also broad with highcoupon bonds in the 10 to 14% range
• Almost all U.K. corporate bonds are callable
term bonds
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11-20
Corporate Bonds
• Eurozone Corporate Bonds
• Pure corporate bonds that include industrial and
utility firms (about 15%)
• Securitized/collaterlized bonds that include
indirect corporate borrowing (about 12%)
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11-21
International Bonds
• Foreign bonds are sold in one country and
currency by a borrower of a different
nationality
• For example, Canadian dollar-denominated bonds
sold in Canada by a Japanese firm (Maple bonds)
• Eurobonds are securities denominated in
U.S. dollars and underwritten by
international bond syndicates and sold to
investors outside the U.S.
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11-22
International Bonds
• United States
• Yankee bonds register with SEC
• Eurodollar bond market affected by changes in
value of U.S. dollar
• Japan
• Samurai bonds: Yen denominated issued by nonJapanese firms in Japan
• Euroyen bonds: Yen denominated, sold outside
Japan
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11-23
International Bonds
• United Kingdom
• Bulldog bonds are sterling-denominated bonds
issued by non-English firms and sold in London
• Eurosterling bonds are sold in markets outside
London by international syndicates
• Eurozone
• Market popular among foreign issuers including
issuers domiciled in the U.S.
• Impressive growth in Eurobonds issued by nonresidents
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11-24
Obtaining Information on Bonds
• Less emphasis on fundamental analysis
• Most bond investors rely on rating agencies
for credit analysis
• Market and economic conditions
• Intrinsic bond features
• National Association of Securities Dealers
(NASD) through Trade Reporting and
Compliance Engine (TRACE)
• Release more timely information
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11-25
Interpreting Bond Quotes
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11-26
Interpreting Bond Quotes
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407 International Inc.
6.05% coupon
Paid semi-annually
Maturity July 27 ’09
Last Price traded $101.76
Yield, based on last price, is
3.82%
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11-27