chapter 13 note - Chapter13 The Bond Market By Dr. M....

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1 Chapter 13 The Bond Market By Dr. M. Metghalchi General Features of Bonds Bond = a long-term debt (Liability) with specified amount of interest and specified maturity date. If a Corporation wants to borrow, they issue a bond (Corporate bonds). If a government wants to borrow, they issue a bond (Government bonds) If a municipality wants to borrow, they issue a bond (Municipal bonds) The indenture is the legal document that gives the terms of the bond (e.g., maturity date, sinking fund, call penalty, and other constraints specific in the loan). Since individual owners will not know these terms and cannot enforce them, a trustee is appointed who enforces the terms of the indenture. The coupon is the specified rate of interest, usually expressed as a percentage of the principal The current rate of interest is the rate on comparable debt being issued today. While the coupon rate of interest and the current are the same when the bond is issued, fluctuations in interest rate imply that the current rate will differ from the coupon rate after the bond is issued. It is the difference between the coupon and current rates that affects the market price of the bond, since the bond must trade to offer a yield that is comparable to the current rate. Debentures are unsecured; they have no collateral to support the bond. Secured bonds have specified collateral which may be sold to pay interest and redeem the bonds. A sinking fund is a mandatory payment that facilitates retiring a bond. A call feature gives the issuer the right to retire (“call”) the bond prior to maturity. Mortgage bonds and equipment trust certificates are both secured bonds. The difference is the collateral. Mortgage bonds are secured by property (i.e., real estate). Equipment trust certificates are secured equipment such as railroad cars, airplanes, and vehicles. This question facilitates a
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2 discussion of the quality of collateral. For example, a mortgage bond may not be safer than unsecured debt if the property cannot be readily sold (e.g., a nuclear power plant). A serial bond has a specified amount of debt maturing each year (e.g., Exhibit 13.5). A term bond matures at a specified date. Term bonds often have a sinking fund, which periodically retires a proportion of the debt issue. From the investor's viewpoint the difference is knowing when the bond will be retired. With a serial bond issue, the retirement date is known with certainty (excluding default). With a term bond and a sinking fund, retirement could occur before maturity but when that will occur is not known. Coupon bonds pay interest periodically (usually every six months) while a zero coupon bond makes no interest payments. The bond is sold for a discount and the interest accrues and paid when the bond is redeemed. Bonds rated triple-B or better are considered investment grade. High-yield bonds (or “junk”
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chapter 13 note - Chapter13 The Bond Market By Dr. M....

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