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Stock Market Analysis and Personal Finance Mr. Bernstein Bonds (aka Fixed Income) pp 306-325 March 4, 2015 Stock Market Analysis & Personal Finance Mr. Bernstein Bonds Bond is a contract to repay a loan on a given maturity date. Face value = final payout ( ~ loan amount) Bonds are traded Over the Counter (OTC) – there is no meaningful exchange 2 Stock Market Analysis & Personal Finance Mr. Bernstein Types of Bonds Debentures, or unsecured bonds, are backed only by the reputation of the issuer. Most corporate bonds are debentures Mortgage bonds are backed by a lien on a home or other real estate Secured bonds are backed by a lien on collateral Convertible bonds can be converted into stock Bond contracts may have other provisions called covenants Junior debt is subordinated to senior debt Floaters have coupons which adjust with interest rates 3 Stock Market Analysis & Personal Finance Mr. Bernstein Why Buy Bonds? Interest Income Capital Gains When interest rates fall, bond prices rise When interest rates rise, bond prices fall 4 Stock Market Analysis & Personal Finance Mr. Bernstein Why Buy Bonds? Interest Income Current Yield = Annual Income / Price Capital Gains When interest rates fall, bond prices rise When interest rates rise, bond prices fall 5 Stock Market Analysis & Personal Finance Mr. Bernstein Why Buy Bonds? Interest Income Capital Gains When interest rates fall, bond prices rise When interest rates rise, bond prices fall Example: Exxon 5% due 4/5/2023…at 5% yield bond price =100. At 4% yield bond price = 110. Why? 5% coupon is reduced by capital loss of 10% over ten years, or 1% per year. 6 Stock Market Analysis & Personal Finance Mr. Bernstein Why Buy Bonds? Yield to Maturity = Coupon Income + (Pymt at maturity - Price Paid) Price Paid Yield to Maturity is the primary measure of a bond’s value 7 Stock Market Analysis & Personal Finance Mr. Bernstein Bond Ratings Ratings Agencies rate bonds based on the likelihood of repayment at maturity Moody’s, Standard & Poor’s and Fitch are the three major Rating Agencies Bonds are rated from D to AAA BBB and above are “Investment Grade” BB and below are “High Yield” or “Junk” bonds 8 Stock Market Analysis & Personal Finance Mr. Bernstein Bond Ratings Ratings Agencies are paid by issuers of new bonds, i.e. corporations, finance companies Is this a conflict of interest? Can investors rely on ratings? 9 Stock Market Analysis & Personal Finance Mr. Bernstein Bond Pricing Investors generally demand more yield for: Higher perceived risk of repayment Higher perceived risk of inflation Longer maturities Relative value is determined by the difference between the Yield to Maturity and the yield on a comparable maturity US Treasury bond (the Spread to Treasuries) Corporate Bond Price Information (FINRA) http://cxa.gtm.idmanagedsolutions.com/finra/BondCenter /Default.aspx 10 Stock Market Analysis & Personal Finance Mr. Bernstein Bond Pricing To receive a higher yield to maturity, what component of the Yield to Maturity formula must change? Yield to Maturity = Coupon Income + (Pymt at maturity - Price Paid) Price Paid 11
