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Reporter no.

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THE BOND
MARKET
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WHAT IS BOND?
 Bond is a fixed income instrument that represents a
loan made by an investor to a barrower(typically
corporate or governmental).
 Between the Lender and the Barrower that includes
the details of the loan and its payments.
 Bonds are used by companies, municipalities, states,
and sovereign governments to finance projects and
operations.
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 Owners of bonds are debtholders or creditors, of the


issuer.
 Bond details include the end date when the principal
of the loan is due to be paid to the bond owner and
usually includes the terms for variable or fixed
interest payments made by the barrower.
KIND OF BONDS
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 Debenture Bonds

They are the unsecured bond issued


against the general credit standing of the issuer.
Usually this bonds generates higher interest
rates than the other types of bonds. They may
also be attractive by the inclusion of special
features, such as profit sharing, conversion
privilege, and a covenant of equal coverage.
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 Collateral Trust Bonds

Are secured by a pledge of corporate


stocks and bonds, and evidences of
indebtedness of other corporations which are
owned by the issuing corporation. Holders of
the collateral trust bonds could have recourse
not only against the issuing corporation but also
against the securities offered as collateral.
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 Mortgage Bonds

They are bonded indebtedness secured by


a mortgage or real properties of the
corporation. In case issuing corporation
defaults, claims of bondholders may be
satisfied out of the proceeds from the sale f
assets given as collateral.
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 Sinking Fund Bonds

Are bonded indebtedness requiring the


compulsory maintenance of a sinking fund to
redeem the bonds at maturity. A sinking fund is a
reserve accumulated from the annual income of
the company used for a specific purpose.
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 Registered Bonds

Is one which is issued in the name of a


particular person or entity. The names of the
bondholders are registered in the book of the
corporation. Such instruments could be
negotiable by endorsement and delivery and
registered in the same name of the new owner
in the books of the corporation.
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 Guaranteed Bonds

They are bond, the principal and interest


payments of which are guaranteed by a
company other than the issuing corporation.
They are usually arise due to reorganization
and consolidation.
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 Convertible Bonds

These are bonds which could be exchanged


with other securities of the corporation within the
duration of the bonded indebtedness. The
conversion clause usually indicates the rate and
time at which they could be converted.
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Redeemable Bonds
They are bonds which are subjected to call,
redemption, or repurchase before they are due.
Redemption may either be optional or mandatory.
Optional redemption – means that the corporation may
or may not redeem the bonds depending on the
circumstance prevailing.
Mandatory Redemption – the corporation is required to
redeem the bonded indebtedness within specified time.
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 Serial Bonds

They are bonded indebtedness of a single


issue but are divided into groups of different
maturity dates and could possibly have variable
terms and conditions. Serial redemption which
eases amortization payments of the principal.
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 Income Bonds

Interest payments of income bonds are


dependent on the happening of an event or after
the lapse of a certain period of time. These
types of bonds are usually issued to organizers
of a corporation during early years of the firm’s
operation, or if the firm is in the process of
reorganization.
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 Coupon Bonds

They are bonds with detachable coupon


which evidence interest obligations payable at
specified periods. This interest coupons may be
negotiated separately from the bond.
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 Profit sharing Bonds

These bonds are allowed to participate in


the earnings of the company in addition to the
interest payments. This feature is usually
attached to low-grade bonds so as to enhance
their sale ability.
INTEREST RATES
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 The proportion of a loan that is


charged as interest to the borrower,
typically expressed as an annual
percentage of the loan outstanding.
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BOND PRICE
 The present discounted value of the future cash stream
generated by loan.

 It refers to the sum of the present value of all likely coupon


payments plus the present value of the par value oat
maturity.

 Lastly, to calculate the bond price one has to simply


discount the known future cash flow
z Relationship Between
Interest Rate and Bond
Price
- Interest rate and bond price have an inverse relationship;

- As interest rates change, the value of


existing bonds go either up or down. If
interest rates increase, the value of bonds
sold at lower interest rates and decline in
value. If interest rates decline, the value of
bonds sold at higher interest rates increase
in value.
 Example: On September 1, 2012 you buy a
$1000

 An Example On September 1, 2012 you buy a


$1,000 bond with a 10% coupon paid annually,
with a two- year maturity. This bond will pay you
$50 interest at 6 months, another $50 interest at
12 months, another $50 at 18 months, and
another $50, plus $1,000 at the end of month 24.
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INTEREST RATE
 An interest rate is a fee that you are charged for
borrowing money, expressed as a percentage of the
total amount of the loan. So if you borrow money,
either in a home, car or personal loan, you pay
interest on it. If you’ve got your money put away in
a bank, either in a savings account, term deposit or
bank account, that more or less amounts to lending
the bank your money, and so you will be paid
interest as a lender.
Why do you pay interest?

 Interest is basically the cost of money. You’re


paying for the ability to use money you
haven’t yet accumulated, so interest is an
incentive for the bank to lend you money and
a premium for the risk they take in lending to
you. Charging interest is one of the ways
lenders make their profit.
Interest is usually calculated on
two ways:

• Simple Interest
• Compound Interest
 The formula for simple interest is:

Simple Interest = principal x annual interest rate x years

Where will I earn simple interest?


-If you’ve stashed your savings in a term deposit,
you’ll earn simple interest.
Example:
ABC lends a sum of $5000 at 10% per annum for a period of
5 years. Compute the Simple Interest and total amount due
after 5years.
Simple Interest = principal x annual interest rate x years

Principal: $5000
Interest Rate: 10% per annum
Time period (in years) = 5
Simple Interest = $5000 x 10% x 5
= $2500

Total Simple Interest for 5 years = $2500

Amount due after 5 years = Principal + Simple


Interest

= $5000 + $2500
Amount due after 5 years = $7500
COMPOUND INTEREST

 The concept of compound interest is that


interest is added back to the principal
sum so that interest is gained on that
already-accumulated interest during the
next compounding period.
 The formula for compound interest is:

Compound Interest = principal x (1 + interest rate) years

 The formula for compound interest, including principal sum, is:

A = P (1 + r/n) (nt)

Where:

 A = the future value of the investment/loan, including interest

 P = the principal investment amount (the initial deposit or loan amount)

 r = the annual interest rate (decimal)

 n = the number of times that interest is compounded per unit t

 t = the time the money is invested or borrowed for.


Example:
 If an amount of $5,000 is deposited into a savings account
at an annual interest rate of 5%, compounded monthly,
the value of the investment after 10 years can be calculated
as follows...
 P = 5000.
r = 5/100 = 0.05 (decimal).
n = 12.
t = 10.
 If we plug those figures into the formula, we get the
following:
 A = 5000 (1 + 0.05 / 12) (12 * 10) = 8235.05.

 So, the investment balance after 10 years


is $8,235.05.
Types of interest rates
Fixed interest rates
A fixed interest rate is set at a certain percentage for the life
of your loan or account. For something like a home loan, this
might make budgeting a little easier, because you’ll pay the
same amount of interest each month.
Variable interest rates
A variable interest rate is an rate that can change from time
to time.
Comparison rate

The comparison rate is used to help buyers


understand what a loan will really cost them.
It’s given as a percentage value, and takes
into account interest rates, fees and charges
so that you can more easily compare what
you’re getting when choosing a loan.
RATE OF RETURN
 A Rate of Return (ROR) is the gain or loss of an
investment over a certain period of time. In other
words, the rate of return is the gain (or loss)
compared to the cost of an initial investment,
typically expressed in the form of a percentage.
When the ROR is positive, it is considered a gain
and when the ROR is negative, it reflects a loss
on the investment.
Rate of Return formula :

((Current value - original value) / original value) x


100 = rate of return

RoR formula is an easy-to-use tool. There are two major numbers


needed to calculate the rate of return:

 Current value: the current value of the item.

 Original value: the price at which you purchased the item.


Example Rate of Return Calculation
 Adam is a retail investor and decides to purchase 10
shares of Company A at a per unit price of $20.
Adam holds onto shares of Company A for 2 years.
In that time frame, Company A paid yearly
dividends of $1 per share. After holding them for 2
years, Adam decides to sell all 10 shares of Company
A at an ex-dividend price of $25. Adam would like to
determine the rate of return during the two years he
owned the shares.
 To determine the rate of return, first
calculate the amount of dividends he
received over the two-year period:

 10 shares x ($1 annual dividend x 2) =


$20 in dividends from 10 shares
 Next, calculate how much he sold the shares for:

 10 shares x $25 = $250 (Gain from selling 10 shares)

 Lastly, determine how much it cost Adam to purchase 10


shares of Company A:
 10 shares x $20 = $200 (Cost of purchasing 10 shares)

 Plug all the numbers into the rate of return formula:

 = (($250 + $20 – $200) / $200) x 100 = 35%

 Therefore, Adam realized a 35% return on his shares over


the two-year period.
Difference between INTEREST
RATE& RATE OF RETURN
 Interest Rate  Rate of Return
 Interest rate implies that the  Rate of return implies the
subject involves a loan. subject involves the
expected profit from an
 The interest rate is the rate
investment.
charged by a lender on a loan
for the project. The interest  The gain or loss on an
rate is based on the borrower's investment over a specified
credit rating and the bank's period, expressed as a
assessment of project percentage increase over the
feasibility and profits. initial investment cost.
Nominal Interest Rates
 are the rate of return which an investor or
borrower will get or have to pay in the market
without any adjustment for inflation.
 ex. if you have deposited ₱100 in your bank
account and your bank is offering a 5% per
annum interest rate you will have
₱105(100+0.05*100)
Real Interest Rates
 Nominal interest is a quite easy concept to understand.
But when we see the effect of inflation on top of that,
things become more interesting.
 ex. depositing money in a bank will give us 5% interest
and we will earn ₱5 in interest. But if the inflation is 3%
per annum, it means that goods and services which we
can buy at, say ₱100 we have to pay ₱103 now for the
same amount of goods and services. so effectively , we
have earned only ₱2(₱5-₱3)
Difference
Between
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Primary
Market
VS
Secondary
The primary market is where securities are created. It’s
in this market that firms float new stocks and bonds to
the public for the first time. An initial public offering, or
IPO, is an example of a primary market. An IPO occurs
when a private company issues stock to the public for
the first time.

The secondary market is commonly referred to as the


stock market. The securities are firstly offered in the
primary market to the general public for the subscription
where a company receives money from the investors
and the investors get the securities; thereafter they are
listed on the stock exchange for the purpose of trading.
Primary Market

The primary market refers to the market where


securities are created, while the secondary market is
one in which they are traded among investors. Various
types of issues made by the corporation are a Public
issue, Offer for Sale, Right Issue, Bonus Issue, Issue of
IDR, etc. The company that brings the IPO is known as
the issuer, and the process is regarded as a public
issue. The process includes many investment banks
and underwriters through which the
shares, debentures, and bonds can directly be sold to
the investors.
1. Public Issue
As the name suggests, public issue means
selling securities to the public at large, such as
IPO. It is the most vital method to sell financial
securities.

2. Rights Issue
Whenever a company needs to raise
supplementary equity capital, the shares have to
be offered to present shareholders on a pro-rata
basis, which is known as the Rights Issue.
3. Private Placement
This is about selling securities to a restricted
number of classy investors like frequent
investors, venture capital funds, mutual funds,
and banks comes under Private Placement.

4. Preferential Allotment
When a listed company issues equity shares to a
selected number of investors at a price that may
or may not be pertaining to the market price is
known as Preferential Allotment.
Secondary Market
This includes the New York Stock Exchange
(NYSE), NASDAQ and all major exchanges around the
world. The defining characteristic of the secondary
market is that investors trade among themselves. In this
market existing shares, debentures, bonds, options,
commercial papers, treasury bills, etc. of the corporates
are traded amongst investors. The secondary market
can either be an auction market where trading of
securities is done through the stock exchange or a
dealer market, popularly known as Over The Counter
where trading is done without using the platform of the
stock exchange.
1. Auction Market
An auction market is a place where buyers and sellers
convene at a place and announce the rate at which they are
willing to sell or buy securities. They offer either the ‘bid’ or
‘ask’ prices, publicly. Since all buyers and sellers are
convening at the same place, there is no need for investors to
seek out profitable options. Everything is announced publicly
and interested investors can make their choice easily.

2. Dealer Market
In a dealer market, none of the parties convene at a common
location. Instead, buying and selling of securities happen
through electronic networks which usually fax machines,
telephones or custom order-matching machines.
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Economic forces that determine bond


prices
3 factors or forces that affect bond prices
 Interest rates.

 Inflation.

 Credit ratings.
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1. Interest rates
 In general, when interest rates rise, bond prices fall.
When interest rates fall, bond prices rise.
 Example – You own a bond paying 3% interest.
When interest rates are low – say 1% – your interest
rate is higher than the going rate. This makes your
bond attractive to other investors. But if interest
rates rise to 5%, your bond is less attractive.
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2. Inflation
 In general, when inflation is on the rise, bond prices
fall. When inflation is decreasing, bond prices rise.
That’s because rising inflation erodes the purchasing
power of what you’ll earn on your investment. In
other words, when your bond matures, the return
you’ve earned on your investment will be worth less
in today’s dollars.
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3. Credit ratings

 Credit rating agencies assign credit ratings to bond issuers


and to specific bonds. A credit rating can provide information
about an issuer’s ability to make interest payments and
repay the principal on a bond.

 In general, the higher the credit rating, the more likely an


issuer is to meet its payment obligations – at least in the
opinion of the rating agency. If the issuer’s credit rating goes
up, the price of its bonds will rise. If the rating goes down, it
will drive their bond prices lower.
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