Chapter 6 - BOND MARKETS
One or more year to maturity, e.g., bonds (CH 6), mortgages (CH 7) and stocks (CH
are long-term debt obligations of companies or governments to fund long-term investments in
long-term 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 6-1, p. 155. In 2004, Corporate bonds (57.9%), T-Bonds (25.1%), Municipal bonds (17%).
See Figure 6-2, 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.
One-year maturity or less. Sold on a discount from face value basis, like a zero coupon.
1-10 year original maturity, semi-annual coupons. See Figure 6-3 on p. 157.
10-30 year original maturity, semi-annual coupons.
1) Fixed nominal coupon
rate bonds with fixed principal, and 2) Inflation-indexed bonds, fixed real rate with an adjustment of
actual inflation for coupons and principal (TIPS).
See Table 6-1, p. 159, from WSJ in Nov 2004. Maturities from Nov 2004 to April 2032.
bonds are selling at a premium. Why?
STRIPs are zero-coupon Treasuries, created from a regular coupon T-bonds, where the coupons are
separated (stripped) from the original bond, and sold separately, see Figure 6-4, p. 160 and Table 6-2,
p. 161. Before the Treasury issued STRIPs in 1985, investment banks like Merrill-Lynch created zero
coupon bonds from regular T-bonds 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 6-2 on p. 161. 5-year zero-coupon bonds are available @8% for
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 6-3 (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