FIN 300 Fundamentals of Finance Bonds Pt.1 Chapter 8 1 FIN 300 - Bonds Pt. 1
Bonds • What is a bond? FIN 300 - Bonds Pt. 1 2
Bonds • Answers: – Loan – Way for a business or governmental entity to borrow money – Form of debt financing • Or, raising debt “capital” to fund investments of a business or government – Contractual promise to pay a schedule of specific payments (or, cash flows) in the future • Failure to make payment results in default and/or potential bankruptcy FIN 300 - Bonds Pt. 1 3
Bonds • More specifically a bond is a type of “security” – A legal claim on the assets of the bond’s issuer – May be traded back-and-forth • A bank may sell a loan – but, we think of bonds as assets that are more easily standardized and traded • In fact, a large number of loans (mortgages, home equity, car, student, credit card receivables, business loans, etc.) are sold off, pooled, and re-packaged as bonds, which are easier to sell than the original loans FIN 300 - Bonds Pt. 1 4
Bond Issuers and Markets • Treasury – U.S. Gov’t debt – Massive and highly liquid (easily traded) segment of the bond market – Widely held and very frequently traded around the world • Corporate – Issued by companies • Municipal (“Muni’s”) – Issued by any level of government (other than federal) – State, county, city, state university, water district, school district, tollroad, etc. – Tax Exempt – interest is non-taxable by IRS and (typically) the same state FIN 300 - Bonds Pt. 1 5
Bond Markets • Domestic vs. International – Investors or financial institutions may hold U.S. or foreign bonds • Sovereign debt – issued by a government • Foreign corporations • Other international entities FIN 300 - Bonds Pt. 1 6
Bond Markets • A few points - FYI – Bonds do not trade on organized “exchanges,” such as the New York Stock Exchange (NYSE) or NASDAQ – Bonds trade over-the-counter (OTC) • Trades are between individual bond “dealers,” which are types of banks – Most of us don’t hold individual bonds • We own them via mutual funds, pension funds, other retirement funds such as 401k, etc. – Many bonds are owned by financial firms such as banks, life insurance companies, etc. FIN 300 - Bonds Pt. 1 7
Bond Ratings • Bonds tend to be more standardized • Investors care less about specific issuer • Investors care more about the general category • Treasury vs. Corporate vs. Municipal • Maturity – life of the bond • Rating of the issuer – Investment grade – many investors and investment funds will only own bonds with a fairly high credit rating – Speculative grade – aka. “junk” bonds – these investors are taking on a greater risk of default in order to get a higher return FIN 300 - Bonds Pt. 1 8
Bond Ratings • There are 3 major companies that issue bond ratings – based on default risk – Standard & Poor’s (S&P), Moody’s, and Fitch • S&P is the most famous for their ratings – AAA is the highest, followed by AA, A, BBB, BB, etc.
You've reached the end of your free preview.
Want to read all 31 pages?