Chapter 6  BOND MARKETS
Capital Markets:
One or more year to maturity, e.g., bonds (CH 6), mortgages (CH 7) and stocks (CH
9).
BONDS
are longterm debt obligations of companies or governments to fund longterm investments in
longterm assets, e.g., capital expenditure projects (property, plant, equipment, real estate, highways,
etc.). Bond issuers promise to pay face value ($1000) on maturity, and periodic coupon/interest
payments: PMT = Coupon Rate (%) x Face Value ($1000).
See Figure 61, p. 155. In 2004, Corporate bonds (57.9%), TBonds (25.1%), Municipal bonds (17%).
See Figure 62, p. 156, $7.43T National Debt in 2004, about 50% Treasury securities. National debt =
accumulation of outstanding debt from all previous deficits, see formula on p. 155.
TBills:
Oneyear maturity or less. Sold on a discount from face value basis, like a zero coupon.
TNotes:
110 year original maturity, semiannual coupons. See Figure 63 on p. 157.
TBonds:
1030 year original maturity, semiannual coupons.
Two types:
1) Fixed nominal coupon
rate bonds with fixed principal, and 2) Inflationindexed bonds, fixed real rate with an adjustment of
actual inflation for coupons and principal (TIPS).
See Table 61, p. 159, from WSJ in Nov 2004. Maturities from Nov 2004 to April 2032.
Note:
Most
bonds are selling at a premium. Why?
STRIPs are zerocoupon Treasuries, created from a regular coupon Tbonds, where the coupons are
separated (stripped) from the original bond, and sold separately, see Figure 64, p. 160 and Table 62,
p. 161. Before the Treasury issued STRIPs in 1985, investment banks like MerrillLynch created zero
coupon bonds from regular Tbonds by stripping the coupons and selling them separately.
Market for STRIPs:
Life insurance companies or pension funds who want to invest to guarantee a
fixed payoff amount, on a specific maturity date, state lotteries who invest to guarantee a fixed annual
amount for payout, etc. Why not invest in a coupon bond for the same purpose?
Example 62 on p. 161. 5year zerocoupon bonds are available @8% for
N
I
PV*
PMT FV
5
8
0 1000
To make a lump sum payment of $1,469,328 in 5 years, the insurer should invest $1m now in approx.
1469 of these bonds ($680.58 x 1469 bonds ≈ $1m), to guarantee the payoff in five years and
immunize against interest rate risk.
Example 63 (p. 162), solve for YTM on a STRIP, where P = 95 11/32 (ASKED) or 95.34375% (11/32
= .34375) of Face Value, maturity in 1.764384 years.
BUS 468 / MGT 568: FINANCIAL MARKETS – CH 6
Professor Mark J. Perry
1
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ANNUAL:
N
I*
PV
PMT FV
1.764384
(95.34375) 0 100
SEMIANNUAL
N
I*
PV
PMT FV
3.52876
(95.34375)
0 100
Example 64 (p. 163), Solve for Price on TNote #1.
N
I
PV*
PMT FV
3.3589
1.345
3.5
100
P = $107.0312 (or $1,070.31 per $1000 face value bond).
To quote in 32nds, ignore the $107, and take .0312 x 32 = 0.9984, round to the closest whole number 1,
and therefore: P = 107 1/32, or 1071
Solve for Price on TNote #2
N
I
PV*
PMT FV
3.3589 1.355
1.375
100
P = 100.0652 or $1,000.65 per $1000 face value, and .0652 x 32 = 2.0864 or
P = 100 2/32, or 1002
When coupon bonds are sold, they usually have some Accrued Interest, the interest accrued from the
time between the last coupon payment, and the current sale date. See Figure 65 on p. 164. 81 days
have past since the last coupon payment on May 15, 2007, and there are 103 days until the next
payment, and there are 184 days in the entire period between coupon payments.
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 Spring '11
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 Financial Markets, investment bank, Bearer Bonds, Professor Mark J. Perry

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