c19c-hs - 19c. Bonds and Bond Pricing When we think about...

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19c. Bonds and Bond Pricing When we think about investments (in layman’s terms), the two types of investments that often come to mind are stocks and bonds. These two types of investments, though often lumped together, are very different. While the stock market is based on the buying and selling of ownership of a company, the bond market is based on the buying and selling of owed debt. When a bond is written and issued, the issuer , or writer, is writing an IOU to some lender. The way the issuer of a bond attracts a lender and the reason a lender wants to lend is because bonds pay interest. The issuer is borrowing money now and promising to pay back more money in the future. Why would a company or government or university choose to issue bonds? Well, bonds allow the issuer of the bond to borrow money or capital now and pay later. In this way, the government can use money now to fund a new program or a corporation can finance their new project and use later profits to pay back the bonds. There are many types of bonds. Most pay interest periodically and then the principal , the amount borrowed, at maturity , the date upon which the writer of the bond must pay back the principal. Bonds can vary based whether or not they are backed by collateral. Secured bonds are bonds “secured” with assets as collateral, meaning if the issuer cannot pay for the bonds, the issuer’s promised assets will be used. These assets can be land or real estate or other items of value. Unsecured bonds are not backed by anything but the general reputation and good credit of the borrower. Bonds can also differ based on how they mature. Term bonds are paid back on a single appointed date while serial bonds are paid back in installments. How corporations treat ownership of their bonds can differ. Until recently, most bonds were bearer bonds . This meant whoever had the bond in their possession could receive the interest payment by tearing off a coupon and exchanging the coupon from the bond for the interest payment from the corporation. Today, most bonds are registered bonds . If a corporation issues a bond to a specific owner, this is a registered bond. This means the corporation has on record the owner of the bond and sends him or her the interest payments. The first step in the bond market is issuing the bonds. The number of bonds, the principal and interest rate must all be decided. The principal and interest rate of the bond will not change once the bonds are printed and these are what determine the amount beyond the principal the lender will receive. Then the bonds are sold. Ch 19.c.
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This note was uploaded on 09/25/2008 for the course ECON 160 taught by Professor Baim during the Summer '98 term at UCLA.

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c19c-hs - 19c. Bonds and Bond Pricing When we think about...

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