Stock Market Analysis and
Personal Finance
Mr. Bernstein
Bonds (aka Fixed Income)
pp 306-325
October 2015
Stock Market Analysis
& Personal Finance
Mr. Bernstein
Bonds
Bond is a contract to repay a loan on a given
maturity date.
Face value = final payout ( ~ loan amount)
Bonds are traded Over the Counter (OTC) – there is no
meaningful exchange
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Types of Bonds
Debentures, or unsecured bonds, are backed only by the
reputation of the issuer. Most corporate bonds are
debentures
Mortgage bonds are backed by a lien on a home or other
real estate
Secured bonds are backed by a lien on collateral
Convertible bonds can be converted into stock
Bond contracts may have other provisions called covenants
Junior debt is subordinated to senior debt
Floaters have coupons which adjust with interest rates
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Why Buy Bonds?
Interest Income
Capital Gains
When interest rates fall, bond prices rise
When interest rates rise, bond prices fall
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Why Buy Bonds?
Interest Income
Current Yield = Annual Income / Price
Capital Gains
When interest rates fall, bond prices rise
When interest rates rise, bond prices fall
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Why Buy Bonds?
Interest Income
Capital Gains
When interest rates fall, bond prices rise
When interest rates rise, bond prices fall
Example: Exxon 5% due 4/5/2023…at 5% yield
bond price =100. At 4% yield bond price = 110.
Why? 5% coupon is reduced by capital loss of
10% over ten years, or 1% per year.
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Why Buy Bonds?
Yield to Maturity =
Coupon Income + (Pymt at maturity - Price Paid)
Price Paid
Yield to Maturity is the primary measure of a
bond’s value
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Bond Ratings
Ratings Agencies rate bonds based on the
likelihood of repayment at maturity
Moody’s, Standard & Poor’s and Fitch are the
three major Rating Agencies
Bonds are rated from D to AAA
BBB and above are “Investment Grade”
BB and below are “High Yield” or “Junk” bonds
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Bond Ratings
Ratings Agencies are paid by issuers of new
bonds, i.e. corporations, finance companies
Is this a conflict of interest?
Can investors rely on ratings?
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Bond Pricing
Investors generally demand more yield for:
Higher perceived risk of repayment
Higher perceived risk of inflation
Longer maturities
Relative value is determined by the difference between the
Yield to Maturity and the yield on a comparable maturity
US Treasury bond (the Spread to Treasuries)
Corporate Bond Price Information (FINRA)
http://finra-markets.morningstar.com/MarketData/Default.jsp
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Stock Market Analysis
& Personal Finance
Mr. Bernstein
Bond Pricing
To receive a higher yield to maturity, what
component of the Yield to Maturity formula
must change?
Yield to Maturity =
Coupon Income + (Pymt at maturity - Price Paid)
Price Paid
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