Introduction to Bond Markets
Investments and Portfolio
Management
MB 72
Outline
 Bond Markets Before 1980s and Bond Markets
now
 What are fixed-income securities?
 Participants/Players
 Meaning of a Bond
 Features of a Bond
 Types of Bonds
 Sources of Risk and Return in Debt Securities
 Regulation of Fixed Income Securities
Why a Separate Course on
Fixed Income Securities?
 Markets Prior to 1980s
– Dominated by plain vanilla bonds with simple cash
flow structures
– Valuation was simple and straightforward
 Markets After 1980s
– Complex cash flow structures
– A variety of securities
– Derivative products to facilitate portfolio strategies to
control interest rate risk and to enhance return
– Wider range of investors
 Two thirds of the market value of all the securities
outstanding in world classified as fixed income
 Most participants in the corporate and financial sectors
participate in this market
 Federal governments, state governments, and
municipalities have not choice but to issue fixed income
securities
 Therefore, a need to have well informed participants so
that they understand
– the forces that drive the bond market
– The valuation of complex cash flow structures
– Portfolio management strategies
Meaning of a Bond
 A debt instrument requiring the issuer also called
the debtor or borrower to repay to the
lender/investor the amount borrowed plus interest
over some specified period of time
 A typical “plain vanilla” bond issued in the U.S.
specifies
– A fixed date when the amount borrowed is due
– The contractual amount of interest, which is typically
paid every six months
 Cash flow pattern is know assuming no default
Features of a Bond
Face Value
Maturity
Yield
Callable/Non-callable
Refunding Provisions
Provisions for paying off bonds
Types of Bonds
Zero Coupon Bonds
Floating Rate Bonds
Callable Bonds
Convertibles
Risks of Bonds
Interest Rate Risk
Reinvestment Risk
Call Risk
Default Risk
Inflation Risk
Exchange Rate Risk
Liquidity Risk
Regulation of Bond Markets
 Largely self-regulated
 Federal Reserve and the SEC closely follow this market
 By and large this market is left to operate on its own
 Three major institutions oversee the regulation of the
market:
– The U.S. Treasury
– The Federal Reserve
– The Securities and Exchange Commission
 Goal is to improve market transparency and access to
information for all participants