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363LecNote-Part2 - 3 Bonds 3.1 Bonds Basics Convention Face...

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3 Bonds James Bond is a fi ctional MI6 (UK Secret Intelligence Service) agent whose codename is 007. 3.1 Bonds Basics Convention Face value = Principal. Also called “par value”. Typ- ically $1 , 000 in the U.S. Coupon rate Coupon rate × Principal = Interest paid per year (e.g.) coupon rate = 6% Payment interval and compounding frequency US: at the end of every 6 months, semi-annual Europe: at the end of every year, annual Types of Bonds Zero-coupon bonds: Single payment ( FV : face value or principal) at fu- ture date ( n : maturity). Also called “discount bonds”. The current price of the bond is PV. Periods 0 1 2 · · · n 1 n cash fl ows PV 0 0 · · · 0 FV Coupon bonds: Coupons ( PMT ) paid at the end of each period. At maturity, both coupon and the principal ( FV ) are paid at maturity. Periods 0 1 · · · n 1 n cash fl ows PV PMT · · · PMT PMT + FV
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U.S. Treasury Securities Considered default-free. Treasury Bills (T-Bills): Original maturity 1 year (typically, 13, 26, and 52 weeks). Issued as zero coupon bonds (discount bonds). Treasury Notes (T-Notes): 1 year Original Maturity 10 years (typi- cally 2, 5, and 10 years). Semi-annual coupon payments. Treasury Bonds (T-Bonds): 10 year < Original Maturity. Semi-annual coupon payments. Treasury STRIPS Break out coupons and principal separately. Each stripped payment is traded as zero coupon bond. Treasury In fl ation Protection Securities (TIPS) Principal is linked to the consumer price index. Provide protection against in fl ation. Other Bonds Corporate bonds Issued by corporations. Default and liquidity risk can be large. Municipal bonds Issued by state and local governments. Exempt from federal taxes. Agency bonds Issued by Federal Agencies, e.g., Fannie Mae. Mortgage-backed and other asset-backed securi- ties.
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Bond Credit Rating source: Fidelity’s webpage. Investment grade: Usually Triple-B or higher. Bond rating agencies (e.g., Moody’s, S&P) con- sider, among others, Interest coverage ratio, Leverage, Pro fi tability and its variability, Collateral, ... March 13, 2009, 12:01AM EST The Triple-A Rating: Going Extinct? The AAA credit rating, the gold standard in corpo- rate fi nance, isn’t just an endangered species. ”It’s almost extinct at this point in Corporate America,” says Nicholas Riccio, managing director of Standard & Poor’s Ratings Service. On Mar. 12, Standard & Poor’s took the prized triple- A rating away from General Electric (GE). The move, from AAA to AA+–still at the upper echelon of cor- porate credit quality–was widely expected by fi xed- income investors, who fretted for months over GE’s exposure to bad debt through its GE Capital arm . ... Just Five AAA Holders The downgrade leaves just fi ve U.S. non fi nancial com- panies with the top credit rating from S&P. The triple- A rating seems secure at ExxonMobil (XOM), Johnson & Johnson (JNJ), Automatic Data Processing (ADP), and Microsoft (MSFT). Pharmaceutical giant P fi zer (PFE) also holds a triple-A rating, but on Jan. 26
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