The Bond Market: An Overview
Jake Caldwell
Colgate Finance Club
January 30, 2011
What is a Bond?
• A debt investment (fixed income security) in
which an investor loans money to an entity
(corporate or governmental) that borrows the
funds for a defined period of time at a
fixed interest rate.
• Bonds are used by companies, municipalities,
states and U.S. and foreign governments to
finance a variety of projects and activities.
-Investopedia.com
The Family of Bonds
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Treasuries
Municipal
Agency
Corporate
Residential
Foreign
Terminology
Each Bond has the following:
• Time to Maturity
• Coupon Rate (a.k.a. an interest rate)
• Price (market-price)
• Principal
• Options (call/put)
General Understanding of Pricing
• Bonds trade at a price and have a coupon rate.
• The coupon rate is determined at the time of
purchase.
• An investor pays a principal amount.
• Bonds expire (mature) on a maturity date.
• Holder of a bond receives the coupon semiannually (but rates are given in annual terms)
• When the bond expires, the holder of the bond
receives the principal back.
• **Price move inversely to interest rates**
Default
• Default – when the issuer of the bond does
not pay the coupon to the holder of the bond
• Risk of default = credit rating (Moody’s)
Investment Grade: Aaa – Baa3
Non-investment Grade: Ba1-C1
Other Inherit Risks
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Interest Rate Risk
Prepayment Risk
Call Risk
Reinvestment Risk
* All of these are reflected in the coupon rate.
Yield Curve
• Tells the investor what the price is for taking
on more risk