• A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.
• commonly refered to as fixed-income securities

• maturity date
• par value
• coupon rate
• the bond indenture

• the date is the year bondholders get paid back for the loans they made
• all bonds have one
• at maturity, bondholders receive par value

• the face value of the bond
• assume that the par value for a bond is $1,000 unless otherwise stated in the question
• bond prices are quoted as a percentage of par value, ofteh without the percentage sign
• a bond trading at 100 is trading at 100% of par value ($1,0000
• regarless if a bond is trading at 85 or 105, the investor receives par value at the maturity of the bond, usually with interest along the way

• tells the investor how much annual interest they'll receive
• expressed as a percentage of par value

• the legal agreement between the issuer and the investor

• All contain the same basic inforamtion:
• The maturity date
• the par value
• the coupon rate and interest payment dates
• any collateral securing the bond
• any callable of convertable features
• name of the trustee

• an organization that admisters a bond issue for an institution
• ensurs that the bond isser meets all the terms and conditions associated with the borrowing

• bearer bonds
• partially registered bonds
• fully registered bonds
• book entry certificates

• also known as coupon bonds
• not registered to a particular person's name
• instead, the holder submits coupons to the issuer every six months to receive the stated interest amount
• because of the risk, they are no longer issued
• many of them havent yet matured and are still trading in the market

• also called registered coupon bonds or registered as to principal only
• the principle -not the interest- is registered to the investors name
• therefore, the bearer coupon payments can go to anyone, but only the person named on the bond can claim the principle payment at maturity
• this type of bond is no longer issued, but is still traded in the market

• the most common form of bond certificates
• it is registered in the investors name and does not have any bearer couponds attached
• investor receives the interest automatically

• are recorded in electronic records called book entries
• the investor doesnt receive certificates or coupons
• the U.S governent usually uses this form

• on the series 7, all bearer and partially registered bonds that are in default should be delivered with any unpaid coupons

• Term bonds
• Series bonds
• Serial Bonds

• are all issued at the same time and have the same maturity date
• If a company issues $20,000,000 worth of term bonds they may all mature in 20 years
• Due to the large amount of payment that is due at maturity most corportaions set up a sinking fund
• corporations issue them because they lock in a coupon rate for a long period of time
• investors like to see that a sinking fund is in place because it lowers the chance of default

• issued in successive years but have only one maturity date
• issuers pay interest only on the bonds they've issued so far
• construction companies that are in phases of construction would issue this type of bond

• a portion of the oustanding bonds mature at regular intervals (for example, 10% of the entire issue matures yearly).
• Usually issued by corporations and munis to fund projects that provide regular income streams
• a serial bond that has more bonds maturing on the final maturity date is called a balloon issue

• are backed by collateral, involve a pledge from the issuer that a specific asset (for instance, property) will be sold to pay off the oustanding debt in the event of default
• have a lower yield than unseccured bonds
• are considered a safer investment (think conservative investor)

1. Mortgage bonds
2. Equipment bonds
3. Collateral bonds
4. Guaranteed bonds

• Backed by property that the issuer owns, in the event of a default the issuer has to liquidate the property to pay off the outstanding debts

• usually issued by transportation companies and is backed by equipment that they own
• in the event of a default, it sells the assets backing the bonds to satisfy the bonds

• are backed by financial assets (stocks and bonds) that the issuer owns
• a trustee holds the assets and sells them to pay off bonds in the event of a default

• backed by the firm other than the origianal issuer, usually a parent company
• if the company defaults the parents company pays off the bonds

• are not backed by any assets whatsoever, only the good faith and credit of the issuer
• arnt considered risky for old established companies

1. Debentures
2. Income Bonds

• backed only by the issuers good word and written agreement (the indenture) stating that the issuer will pay the investor interest when due and par value at maturity

• the riskiest of all
• issuer promises to pay par value back at maturity and will make interest payments only if earnings are high enough
• companies in the process of reorganizing offer these bonds at a deep discount
• for test purposes you shouldnt reccomend these bonds to investors who cant afford to take a lot of risk

• There is an inverse relationship between oustanding bond prices and yields
• if interest rates decrease, oustanding bond prices increase and vice versa

•  it is the coupon rate on the face of the bonds

• the annual rate of return on a security
• the CY changes of a bond when the market price changes, you can determine the CY by dividing the annyal interst by the market price
• CY = annual interest ÷ Market Price

• the yield that an investor can expect if holding the bond to maturity
• Takes into account not only the market price but also par value, the coupon rate, and the amount of time until maturity
• Know how to do this on a calculator

• the amount the investore receives if the bond is called prior to maturity

Note!

• if the CY, YTM, or YTV is > than the NY the bond price will drop and vice sersa

• the additional cost that invstors pay when they purchase bonds in the market on top of the market price
• it is due when bonds are purchase between coupon dates, is the portion of the interest still due to the seller
• if an investor hold onto a bond for five months out of a six month period, he or she is entitled to 5/6 of that next interest payment; thats accrued interest

• Accrued interest on corporate and municipal bonds is calculated on a 360-day year and assumes 30-day months
• Accrued interest on U.S government bonds is calculated using the actual days per year and actual days per year
• Accrued interest is calculated from the previous coupon date up to, but not including, the settlement date

• the 31 day months are January, March, May, July, August, October, December
• The rest are 30 day, except for febuary which is 28

• A bond that the issuer has the right to buy back from investors at the price stated on the indenture
• riskier for investors because investors dont know how long they can hold onto the bond
• issued with a higher coupon rate
• most are issued with call protection which is the amount of time that an issuer had to wait before calling the bond
• some also have a call premium which is the amount over par value that an issuer has to pay if calling its bond in the early years

• allow the investor to "put" the bonds back (redeem them) to the issuer at any time at the price stated on the indenture
• these bonds are rarely used

• there is a direct correlation between interest rates and when bonds are called or put.
• Issuers call bonds when interest rates decrease
• investors put bonds when interest rates increase

• bonds that are convertable into common stock
• attractive to investors because investors have an interest in the bond price as well as the price of the underlying stock
• Parity exists when a convertable bond and its underlying stock are trading equally

Conversion Ratio = Par value ÷ Conversion price

Parity price of the bond = market price of the stock x conversion ratio

• Sometimes companies force a conversion by calling bonds at a price that less than parity
• this is advantageous for investors

• T-Bills (treasury bills)
• T-Notes (Treasury Notes)
• T-Bonds (Treasury Bonds)
• T-Strips (seperate trading of registered interest and principle of securities)
• TIPS (treasury inflation protected securities)

• initial maturity of 4, 13, and 26 weeks
• issued at a discount and mature at par

• initial maturity 2,3,5,10 years
• Pay interest every 6 months

• Initial maturity of 10 to 30 years
• pay interest every 6 months

• initial maturity of 6 months to 30 years
• issued at a discount and mature at par

• initial maturity of 5, 10, 20 years
• pay interest every 6 months; par value and interest payments adjust according to inflation or deflation
• are tied to the CPI (consumer price index)

• interest received on U.S government securities is exempt from state and local taxes
• the interest received on municipal bonds is exempt from federal taxes
• When you see a question on the exam about the best investment for a future event (college), the answer will most likely be either zero-coupon bonds or T-STRIPS

• debt securities backed by pools of mortgages
• dont have a set maturity date and are subject to things called extension risk and prepayment risk
• they are broken down into tranches (slices) of varying maturity dates

• the risk that a tranche will be called sooner than expected due to decreasing interest ratesl more people refinance when interest rates are low

• the risk that a tranche will be called later than expected dude to a less than normal amount of refinancing
• occurs when interest rates are high

• all have regular interest payments, but only the tranche with the shortest maturity receives principle payments
• after the shortest tranche is retired, the second-shortest receives  principle payments until that tranche is retiredm and then the principle is paid to the next tranche

• the most common because it has the most certain prepayment date
• the prepayment and extension risk can be somewhat negated by a companion tranche, which assumes a greater degree of risk

• second safest CMO

• TACs protect investors from a rise in the prepayment rate or a fall in interest rates. They do not protect from a fall in the prepayment rate like PACs.

• A class of tranche found in planned amortization class (PAC) and targeted amortization class (TAC) collateralized mortgage obligations (CMOs) that absorbs variable prepayment rates. The companion trache is so named because it is designed to provide support to the main PAC tranche, which has priority in receiving principal and interest payments so as to give its investors steadier and more predictable cash flows. If the actual rate of prepayments differs from the assumptions made at the time the CMO was issued, the difference is absorbed by the companion tranche.

• usually the last tranche in a series of PAC or companion tranches
• dont receive interest or principcal until all other tranches in the series has been retired

• relatively safe short-term loans that can be issued by corporations, banks, the U.S government and municipalities
• have maturities of 1 year or less
• issued at a discount and mature at par
• Types:
• Repruchase Agreements
• Federal Funds
• Corporate Comemercial Paper
• Negotiable Certificates of Deposit
• Eurodollars
• Bankers Acceptances
• T-Bills

• a contract between a buyer and a seller
• the seller of the securities (usually T-Bills) agrees to buy them back at a previously determined price and time
• short term loans

• loans between banks to halp meet reserve requirements
• usually overnight loans for which rates are changing constanly depending on supply and demand

• unsecured corporate debt
• issued at a discount and matures at par value
• issued with an initial maturity of 270 days or less and is exempt from SEC registration

• a CD with a large denomination, usually $1,000,000 or more
• low risk investments and can be sold to other investors

• american dollars held by a foreign bank outside the U.S
• this situation is usually the result of payments made to overseas companies

• a time-draft (short-term credit investment) created by a company whose payment is guaranteed by a bank
• used for importing and exporting goods

• A non-marketable, interest-bearing U.S. government savings bond that is guaranteed to at least double in value over the initial term of the bond, typically 20 years. Most Series EE bonds have a total interest-paying life that extends beyond the original maturity date, up to 30 years from issuance.

• A 20-year non-marketable U.S. government savings bond that pays semi-annual interest based on a coupon rate. This coupon is locked in at a fixed rate for the first 10 years, after which it is reset by the U.S. Treasury for the rest of the bond's life. Interest on Series HH bonds is exempt from state and local - but not federal - taxes.

• The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.