468-6 - Chapter 6 - BOND MARKETS Capital Markets: One or...

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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 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. T-Bills: One-year maturity or less. Sold on a discount from face value basis, like a zero coupon. T-Notes: 1-10 year original maturity, semi-annual coupons. See Figure 6-3 on p. 157. T-Bonds: 10-30 year original maturity, semi-annual coupons. Two types: 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. Note: Most 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 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 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 1
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ANNUAL: N I* PV PMT FV 1.764384 (95.34375) 0 100 SEMI-ANNUAL N I* PV PMT FV 3.52876 (95.34375) 0 100 Example 6-4 (p. 163), Solve for Price on T-Note #1. N
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This note was uploaded on 01/24/2012 for the course MGT 568 taught by Professor Staff during the Spring '11 term at University of Michigan.

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468-6 - Chapter 6 - BOND MARKETS Capital Markets: One or...

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