BOND NOTES

DEFINITION: A bond is a commitment by the issuer (the company that is borrowing the money) to pay a rate of interest for a pre-determined period of time. By selling bonds, the issuing company has raised spending power by borrowing. This is called Debt Financing.

BOND TERMS

The following is a [very crude] example of a corporate bond.

The left side of the bond is called the bond's principal. The $1,000 is the bond's PAR value or the FACE amount. When the bond is first issued,

it is sold for $1,000. Bond holders are loaning the issuing corporation $1,000 in exchange for 30 years of interest. At the end of the term [when the bond matures] the bondholder's $1,000 is returned.

The issuing corporation's name is listed on the face of the bond. In our example case, the issuer is AT&T.

8% in our example is the coupon rate. That is the rate of interest (as an annual rate) promised by the issuing corporation for the use of your money. You are paid 8% of $1,000 per year for as many years as you own this bond. The payments are made semi-annually. We will be glad to know that their is no fancy math necessary to make this calculation. Interest is paid on a simple interest basis. 8% of $1,000 = $80, which will be paid in two $40 installments.

The date listed on the bond's face is the maturity date. Typically 30 years, this is the date that the bondholder is paid $1,000 and the date that the bond dissolves. The debt is paid, this bond issue is over.

The dashed lines toward the bottom of the bond's principal represent the indenture, where the terms and conditions of the bond issue are listed. The indenture could be short or 100 pages long, we will see what special circumstances a corporation could include in the indenture as our study of bonds progress.

The squares to the right of the principal are the bond's coupons.

Principal Bond's coupons. In a 30-year bond, there are 60 coupons

$1000

☺

AT & T

8%

1/1/33

----------------

Indenture

---------------

$40

1/1/33

$40

7/1/03

$40

1/1/04

$40

7/1/04

BOND RETIREMENT FEATURES

Being Paid-off @ maturity.

The bond matures naturally.

Retired Serially Serial bonds mature at different dates rather than all at once. A portion of the issue is retired annually throughout the bond's term. Investors can pick maturity dates to meet their needs.

Retired by Sinking Fund

Additional protection to bond holders; a sinking fund forces the issuing company to set aside funds during the bond's term. At maturity, the company has saved the money necessary to retire the principal.

Being Called by the issuer.

Corporate Treasurers and CFO's are no dummies, they install Call Features into the Indenture to protect the company from interest rate risk. An example being if the company borrows money in a high interest rate environment and interest rates fall, as they have in year 2008; the company can refinance the issue as a person would refinance their house to take advantage of the lower rates.

If the bond is FREELY CALLABLE, the investor has NO CALL PROTECTION. The company can call the bond at any time after issue. If the bond is NON CALLABLE, the investor has FULL PROTECTION against the call. The bond will not be retired until it matured. If the bond has a DEFERRED CALL - The investor has LIMITED CALL PROTECTION. The bond may be called within the first 5 years or the last half of its life. Those are examples. The company can name its call features, they have to be spelled out in the Indenture.

BOND RATINGS

This table illustrates ratings of the two principal bond rating agencies, Standard & Poors (S&P) and Moody's.

QUALITY S&P Moody's Description

High Grade AAA Aaa

Bonds judged to be of the best quality. They carry the smallest degree of investment risk. Interest payments are protected by a large, stable margin. Principal is secure.

AA Aa

Bonds that are judged to be of high quality by all standards. They are rated lower than the best bonds because margins of protection may not be as large. AAA and AA bonds are referred to as "High Grade."

Medium Grade A A Upper-medium grade obligations. Factors giving security to principal and interest are considered adequate.

Bottom rung of Investment Grade

Bonds BBB Baa

Bonds that are considered as medium-grade obligations -- they are neither highly protected or poorly secured.

Speculative Grade BB Ba Bonds that have speculative elements. Protection of principal and interest may be moderate.

B B

Bonds that lack the characteristics of a desirable investment. There may be small assurance of principal and interest payments over any long period.

Default CCC Caa Bonds of poor standing. These issues may be in default or there may be elements of danger present with respect to principal and interest.

CC Ca Obligations speculative to a high degree. These issues are often in default.

C Lowest rated class in Moody's list.

C Rating given to income bonds on which interest is not being paid.

D Issues in arrears in interest and/or principal payments.

BOND YIELDS - Used to evaluate a bond before purchase.

WARNING. NOTICE. ADVICE. As soon as you see a bond coupon rate, the wheels of your brain need to start turning....since the bond's par value is seldom included in bond

information sources, Wall Street, investment professionals, assume that you know it.

Test 2 earns the lowest grades. Semester after semester, the distribution is poor and the points are lost from the following calculations. Students fail to remember to (1) use the

coupon rate to calculate the annual dividend and (2) do not convert a bond quotation into a price.

Know what you are doing.

COUPON RATE/YIELD

Stated on the face of the bond. Technically, the coupon rate is derived by dividing the ANNUAL INTEREST by the PAR value.

CURRENT YIELD

Defined as: ANNUAL INTEREST divided by (MARKET) PRICE. Once the bond is issued and is in the secondary market (has begun trading), an investor may pay a price for the bond different from par. In this case, the annual income divided by the price paid, will give the investor a more accurate yield than the coupon yield. The coupon yield will equal the current yield if the bond can be purchased at par.

YIELD TO MATURITY

The promised compounded rate of return an investor will receive from a bond purchased at the current market price and held to maturity. It captures the coupon interest to be received on the bond as well as any capital gains or losses realized by purchasing at a discount or premium. YTM = {Annual Interest+[(Face Value @ Maturity-Price)/# yrs to maturity]} / [(face value @ maturity + price)/2] REALIZED COMPOUNDED YIELD: The YTM calculation assumes that the investor reinvests all coupons received from a bond at a rate equal to the computed YTM, thereby earning interest-on-interest over the life of the bond. PROMISED YIELD: The YTM is referred to as Promised because investors will only earn that rate if the bond is held to maturity and coupon payments are reinvested at the YTM.

The risk that the investor faces with the YTM calculation is REINVESTMENT risk. The possibility that the coupons CANNOT be reinvested at that YTM.

YIELD-TO-CALL

YTC = {Annual Interest+[(Call Price - Price)/# yrs to call]} / [(Call Price + Price)/2]

The Yield-to-Call calculation is identical to the Yield-to-maturity with logical substitutions of elements. The number of years to maturity in the YTM formula is replaced with the number of years to call. The Face Value @ Maturity is replaced with the Call Price. These are usually the same, BUT the company

may pay a different price from par when the bond is called. Sometimes referred to as a guilt coupon, the firm may add one coupon to the price on the call date, compensating investors (in some way) for calling the bond before maturity.

BOND VALUATION

Bond valuation is the process of calculating the intrinsic value of the bond given changes in market interest rates. This process describes interest rate risk.

For example, we have an 8%, $1,000, 30 year bond, paying $40 semi-annual coupons.

We know that the bond cost $1,000 new, when issued. It costs $1,000 because that is the face value, it also costs $1,000 because that is the present value of its parts. If we calculate the present value of the bond's principal (a single sum) and added it to the present value of the coupons (an annuity), we would have $1,000.

$1000 * ( 1+ .08/2)-60 = $95.06

$40 * [1- ( 1+ .08/2)-60 ] / (.08/2) = $904.94

TOTAL = $1000

The biggest risk of bond ownership is interest rate risk. We know that interest rates and bond prices are inversely related. When interest rates increase, bond prices decrease and vice-versa.

Given our sample bond, let's say that interest rates increase from 8% to 9%. We know that the price of our bond will decrease, but how much? Bond valuation will determine the new price of the bond given this change in the market. The process is the same, we have to take the present value of the bond's principal and add it to the present value of the coupons using the current interest rate of 9%.

$1000 * ( 1+ .09/2)-60 = $71.28

$40 * [1- ( 1+ .09/2)-60 ] / (.09/2) = $825.52

TOTAL = $896.80

The same process would be used for decreasing interest rates.

RISKS AND ADVANTAGES OF BONDS

RISKS

Interest Rate Risk

THIS IS THE BIGGEST RISK OF BOND OWNERSHIP. Bond prices move inversely with interest rates. Other risks can be avoided or minimized, interest rate risk is more difficult to avoid. Usually bond professionals are the only ones that can sufficiently protect a portfolio against this risk.

Default Risk

Second biggest risk, the risk of the issuing corporation filing for bankruptcy protection or otherwise defaulting on their obligation to pay. Default can come in many forms. If the company is late on a coupon payment, if they do not contribute to the sinking fund (if required), if they violate the parameters of the call features, any of these plus many more, constitute default, not just failure to pay. Investors probably perceive the failure to pay as the most serious because they are not getting paid for their investment.

Inflation Risk Since bonds are fixed income securities, inflation risk (rising prices) could consume several percentage points if not all of the bond's rate of return.

Reinvestment Risk

If interest rates have fallen, coupons would be reinvested at a lower interest rate, thus lowering the yield to maturity. [Discussed in Yield-to-Maturity]

Maturity Risk Risk in investing in long term securities.

Call Risk The risk that a callable bond will be called.

Liquidity Risk

This is coupled with quality. Thinly traded bonds may not be quickly sold.

ADVANTAGES

Aside from regular cash payments, Bond holders have a senior position over stock holders in event the firm is liquidated or files for bankruptcy. Bond holders get paid first, then preferred stockholders, then common stockholders.

Debenture Bonds: Are backed only by the "full faith and credit" of the issuer. The bonds are unsecured debt.

ZERO COUPON BONDS

ZERO's Earn interest during the bonds life. They are sold at a "deep discount" from the face amount and mature at face. For example, a zero may be sold for $200 and mature, 20 years later at $1000. The owner gets no interest during that time (hence the name, ZERO coupon).

The primary disadvantages of owning Zero's: •Taxes are paid on earnings annually as if interest was received. The investor will be billed annually for the 'accreted' or accumulated value of the bond. •Zero's can experience violent price swings more than a coupon bond due to their having no periodic coupon payments to buffer changes in market interest rates. These violent price swings

could be used as a distinct advantage for the bondholder, zeros could be purchased when there is an expectation of falling interest rates. When the rates fell, zero prices would rise more than coupon bonds.

12/27/16

GOVERNMENT BONDS

U.S. GOVERNMENT ISSUES

There is no safer debt obligation than those issued by the US Government. US Treasury issues more debt than any other entity. Obligations are backed by the full faith and credit of the US Government. They are free of default risk, are non-callable and are tax exempt on state and local level. Treasuries can be purchased through brokerage firms (with commission) or through the Federal Reserve Banks free of charge.

The three primary marketable securities issued by the Treasury are: Bonds, Notes and Bills.

Type Par Term Coupons Callable Taxable

Bill $10000 3-12 mos. No No Federal Only

Note $1000 2-10 yrs. Yes No Federal Only

Bond $1000 10-30 yrs. Yes No Federal Only

TREASURY BILLS: They are sold at a discount from face value and mature at face value. Federal Reserve Bank holds weekly auctions. Firms and individuals use T-Bills to park cash and defer income taxes into the next calendar year. Taxes are paid when bills mature.

TREASURY NOTES: They pay semi-annual coupons like corporate bonds. TREASURY BONDS: They pay semi-annual coupons like corporate bonds. The 30-year Treasury bond is the flagship of the bond world. Many financial instruments and benchmarks are set off of the 30-year bond rate.

The following table is an excerpt from the Wall Street Journal. Quotations are "a percent of the par value." With the par values of bonds and notes listed in the above table.

On Treasury Bills, they are sold at a discount from the face value (face value is in the above table). They pay no coupons. For a Bill with an Bid discount percentage of 0.105 (this is the last one in the table listed below), we would figure the price like this.

Start with 100% of the par value, subtract the Ask discount (0.105%) then multiply the result by pat ($10,000). Thus: 100% - 0.105% = 99.895% x $10,000 = $9,989.50. Done.

The point here is to calculate the price of a Bill. To purchase the last bill on the table (below), it would cost $9989.50, it would mature on September 20, 2012 for par ($10,000), the investor would earn $10.50 in interest.

U.S. Treasury Quotes TREASURY NOTES & BONDS Tuesday, October 04, 2011 Treasury note and bond data are representative over-the-counter quotations as of 3pm Eastern time. For notes and bonds callable prior to maturity, yields are computed to the earliest call date for issues quoted above par and to the maturity date for issues below par.

Maturity Coupon Bid Asked Chg Asked yield

10/31/2011 1.000 100.0313 100.1016 -0.0078 -0.415

10/31/2011 4.625 100.2969 100.3594 -0.0078 -0.431

11/15/2011 1.750 100.1641 100.2266 0.0000 -0.268

11/30/2011 0.750 100.0781 100.1406 0.0000 -0.159

11/30/2011 4.500 100.6563 100.7188 -0.0078 -0.184

12/15/2011 1.125 100.1797 100.2422 -0.0078 -0.116

12/31/2011 1.000 100.1953 100.2578 -0.0234 -0.084

12/31/2011 4.625 101.0469 101.1172 -0.0391 -0.093

1/15/2012 1.125 100.2656 100.3281 -0.0156 -0.053

1/31/2012 0.875 100.2266 100.2969 -0.0234 -0.046

1/31/2012 4.750 101.4844 101.5469 -0.0313 -0.068

2/15/2012 1.375 100.4453 100.5078 0.0078 -0.026

2/15/2012 4.875 101.7031 101.7813 -0.0156 -0.052

2/29/2012 0.875 100.2969 100.3594 0.0156 -0.011

2/29/2012 4.625 101.8203 101.8828 -0.0234 -0.033

3/15/2012 1.375 100.5469 100.6094 0.0078 0.009

3/31/2012 1.000 100.4375 100.4453 0.0313 0.087

3/31/2012 4.500 102.1094 102.1797 -0.0469 0.020

4/15/2012 1.375 100.6406 100.7109 -0.0078 0.029

4/30/2012 1.000 100.4688 100.5391 -0.0078 0.057

4/30/2012 4.500 102.4688 102.5391 -0.0547 0.051

5/15/2012 1.375 100.7109 100.7813 -0.0469 0.099

5/31/2012 0.750 100.4063 100.4141 0.0391 0.118

5/31/2012 4.750 103.0156 103.0313 0.0000 0.107

6/15/2012 1.875 101.1641 101.2344 -0.0078 0.097

6/30/2012 0.625 100.3125 100.3828 0.0078 0.107

6/30/2012 4.875 103.4453 103.5078 -0.0234 0.110

7/15/2012 1.500 101.0078 101.0703 -0.0078 0.123

7/31/2012 0.625 100.3047 100.3672 -0.0078 0.179

7/31/2012 4.625 103.6563 103.6641 0.0156 0.157

8/15/2012 1.750 101.3594 101.3750 0.0000 0.154

8/15/2012 4.375 103.5938 103.6719 0.0000 0.109

8/31/2012 0.375 100.1563 100.2188 -0.0313 0.134

8/31/2012 4.125 103.5703 103.6016 0.0078 0.138

9/15/2012 1.375 101.1328 101.1406 0.0000 0.168

9/30/2012 0.375 100.1641 100.2344 -0.0234 0.139

9/30/2012 4.250 104.0156 104.0469 -0.0078 0.144

10/15/2012 1.375 101.1875 101.2578 -0.0234 0.151

10/31/2012 0.375 100.1719 100.2422 0.0000 0.150

10/31/2012 3.875 103.9219 103.9844 -0.0078 0.150

11/15/2012 1.375 101.2891 101.3516 -0.0156 0.159

11/15/2012 4.000 104.2500 104.3281 -0.0313 0.102

11/30/2012 0.500 100.3281 100.3984 -0.0078 0.155

11/30/2012 3.375 103.6328 103.7031 -0.0234 0.160

12/15/2012 1.125 101.0703 101.1328 -0.0078 0.176

12/31/2012 0.625 100.4844 100.5547 -0.0156 0.177

12/31/2012 3.625 104.2422 104.3125 -0.0234 0.134

1/15/2013 1.375 101.4453 101.5156 -0.0156 0.187

1/31/2013 0.625 100.5000 100.5625 -0.0313 0.199

1/31/2013 2.875 103.4609 103.5313 -0.0469 0.197

2/15/2013 1.375 101.5156 101.5859 -0.0234 0.209

2/15/2013 3.875 104.9063 104.9844 -0.0313 0.207

2/28/2013 0.625 100.5234 100.5938 -0.0313 0.202

2/28/2013 2.750 103.4922 103.5547 -0.0234 0.214

3/15/2013 1.375 101.6094 101.6797 -0.0313 0.211

3/31/2013 0.750 100.7500 100.8203 -0.0313 0.198

3/31/2013 2.500 103.3281 103.3906 -0.0234 0.215

4/15/2013 1.750 102.2500 102.3203 -0.0234 0.228

4/30/2013 0.625 100.5781 100.6484 -0.0234 0.212

4/30/2013 3.125 104.5000 104.5703 -0.0234 0.210

5/15/2013 1.375 101.7656 101.8359 -0.0234 0.234

5/15/2013 3.625 105.3750 105.4531 -0.0313 0.233

5/31/2013 0.500 100.4063 100.4766 -0.0078 0.212

5/31/2013 3.500 105.3594 105.4219 -0.0156 0.213

6/15/2013 1.125 101.4219 101.4922 -0.0234 0.243

6/30/2013 0.375 100.2031 100.2734 -0.0156 0.218

6/30/2013 3.375 105.3984 105.4609 -0.0078 0.223

7/15/2013 1.000 101.2656 101.3359 -0.0078 0.247

7/31/2013 0.375 100.1953 100.2656 -0.0313 0.229

7/31/2013 3.375 105.6563 105.7266 -0.0156 0.222

8/15/2013 0.750 100.8828 100.9219 -0.0078 0.254

8/15/2013 4.250 107.3594 107.4063 -0.0156 0.259

8/31/2013 0.125 99.7578 99.7969 -0.0156 0.233

8/31/2013 3.125 105.4063 105.4375 0.0313 0.260

9/15/2013 0.750 100.9063 100.9375 -0.0078 0.267

9/30/2013 0.125 99.7500 99.7734 -0.0078 0.240

9/30/2013 3.125 105.6484 105.6797 -0.0156 0.257

10/15/2013 0.500 100.3984 100.4375 -0.0078 0.284

10/31/2013 2.750 105.0547 105.0859 -0.0156 0.285

11/15/2013 0.500 100.3750 100.4141 -0.0313 0.304

11/15/2013 4.250 108.2656 108.3125 -0.0313 0.298

11/30/2013 2.000 103.6094 103.6406 -0.0156 0.303

12/15/2013 0.750 100.9453 100.9766 -0.0234 0.304

12/31/2013 1.500 102.6406 102.6797 -0.0391 0.297

1/15/2014 1.000 101.4844 101.5234 -0.0703 0.328

1/31/2014 1.750 103.2500 103.2813 -0.0547 0.330

2/15/2014 1.250 102.1250 102.1563 -0.0469 0.333

2/15/2014 4.000 108.6094 108.6563 -0.0469 0.317

2/28/2014 1.875 103.6250 103.6641 -0.0625 0.344

3/15/2014 1.250 102.1641 102.2031 -0.0703 0.345

3/31/2014 1.750 103.4297 103.4688 -0.0938 0.348

4/15/2014 1.250 102.2266 102.2578 -0.0547 0.352

4/30/2014 1.875 103.7813 103.8125 -0.1484 0.384

5/15/2014 1.000 101.6016 101.6328 -0.0547 0.372

5/15/2014 4.750 111.3594 111.4063 -0.0625 0.358

5/31/2014 2.250 104.9297 105.0000 -0.0938 0.355

6/15/2014 0.750 101.0078 101.0469 -0.0703 0.360

6/30/2014 2.625 106.0781 106.1172 -0.0781 0.376

7/15/2014 0.625 100.6563 100.6953 -0.0547 0.374

7/31/2014 2.625 106.2344 106.2734 -0.0703 0.387

8/15/2014 0.500 100.3047 100.3438 -0.0547 0.380

8/15/2014 4.250 110.9844 111.0313 -0.0625 0.371

8/31/2014 2.375 105.6641 105.7031 -0.0703 0.398

9/15/2014 0.250 99.5625 99.5938 -0.0547 0.389

9/30/2014 2.375 105.8125 105.8516 -0.0625 0.402

10/31/2014 2.375 105.9219 105.9609 -0.0469 0.419

11/15/2014 4.250 111.7344 111.7813 -0.0625 0.434

11/30/2014 2.125 105.2188 105.2578 -0.0625 0.444

12/31/2014 2.625 106.8906 106.9375 -0.0859 0.463

1/31/2015 2.250 105.8281 105.8672 -0.0234 0.468

2/15/2015 4.000 111.5469 111.5938 -0.1719 0.516

2/15/2015 11.250 135.9063 135.9531 -0.1563 0.459

2/28/2015 2.375 106.2969 106.3516 -0.0703 0.491

3/31/2015 2.500 106.8750 106.9063 -0.0391 0.500

4/30/2015 2.500 106.9453 106.9844 -0.0625 0.523

5/15/2015 4.125 112.8125 112.8594 -0.1406 0.526

5/31/2015 2.125 105.7188 105.7578 -0.0391 0.532

6/30/2015 1.875 104.8125 104.8516 -0.0469 0.561

7/31/2015 1.750 104.4844 104.5234 0.0391 0.552

8/15/2015 4.250 113.8906 113.9375 -0.1406 0.594

8/15/2015 10.625 138.4531 138.4844 0.0000 0.540

8/31/2015 1.250 102.5313 102.5703 -0.1172 0.583

9/30/2015 1.250 102.4609 102.5000 -0.0547 0.614

10/31/2015 1.250 102.3828 102.4219 -0.1094 0.646

11/15/2015 4.500 115.6563 115.6875 -0.0469 0.629

11/15/2015 9.875 137.6563 137.6875 -0.0469 0.584

11/30/2015 1.375 102.8359 102.8750 -0.0703 0.672

12/31/2015 2.125 105.9844 106.0313 -0.1250 0.678

1/31/2016 2.000 105.4141 105.4453 -0.1250 0.718

2/15/2016 4.500 116.1406 116.1719 -0.1719 0.726

2/15/2016 9.250 136.7031 136.7344 -0.1875 0.686

2/29/2016 2.125 105.9922 106.0234 -0.1328 0.733

2/29/2016 2.625 108.1094 108.1719 -0.1406 0.736

3/31/2016 2.250 106.5859 106.6172 -0.1406 0.748

3/31/2016 2.375 107.0469 107.0938 -0.1719 0.764

4/30/2016 2.000 105.4609 105.4922 -0.1250 0.775

4/30/2016 2.625 108.2031 108.2656 -0.1563 0.781

5/15/2016 5.125 119.6719 119.7188 -0.0938 0.765

5/15/2016 7.250 129.4375 129.4688 -0.0938 0.738

5/31/2016 1.750 104.2813 104.3203 -0.1172 0.802

5/31/2016 3.250 111.2344 111.3125 -0.1406 0.770

6/30/2016 1.500 103.0781 103.1172 -0.1094 0.828

6/30/2016 3.250 111.2188 111.2656 -0.1719 0.820

7/31/2016 1.500 103.0391 103.0781 -0.0781 0.847

7/31/2016 3.250 111.4063 111.4531 -0.0938 0.822

8/15/2016 4.875 119.3438 119.3906 0.0625 0.800

8/31/2016 1.000 100.6016 100.6406 -0.0781 0.867

8/31/2016 3.000 110.2031 110.2500 -0.0625 0.861

9/30/2016 1.000 100.5156 100.5625 -0.0625 0.885

9/30/2016 3.000 110.2656 110.2969 -0.0781 0.885

10/31/2016 3.125 110.9375 111.0000 -0.0625 0.901

11/15/2016 4.625 118.5000 118.5469 -0.0938 0.904

11/15/2016 7.500 133.0156 133.0469 -0.0781 0.875

11/30/2016 2.750 109.1406 109.1875 -0.0938 0.920

12/31/2016 3.250 111.7344 111.7813 -0.1250 0.939

1/31/2017 3.125 111.1875 111.2344 -0.0781 0.954

2/15/2017 4.625 119.0938 119.1719 -0.0938 0.949

2/28/2017 3.000 110.5938 110.6719 -0.0781 0.968

3/31/2017 3.250 111.9531 112.0313 -0.1250 0.991

4/30/2017 3.125 111.3906 111.4688 -0.1250 1.003

5/15/2017 4.500 119.0469 119.0938 -0.0938 0.993

5/15/2017 8.750 142.3906 142.4375 -0.0313 0.963

5/31/2017 2.750 109.4375 109.4688 -0.0781 1.022

6/30/2017 2.500 108.0000 108.0313 -0.0938 1.053

7/31/2017 2.375 107.2969 107.3281 -0.0625 1.073

8/15/2017 4.750 120.9375 120.9688 -0.1094 1.052

8/15/2017 8.875 144.5625 144.6094 -0.1875 1.016

8/31/2017 1.875 104.3750 104.4219 -0.0625 1.099

9/30/2017 1.875 104.3438 104.3906 -0.0156 1.115

10/31/2017 1.875 104.2344 104.2656 -0.1250 1.146

11/15/2017 4.250 118.5156 118.5625 -0.0469 1.101

11/30/2017 2.250 106.5000 106.5469 -0.0313 1.145

12/31/2017 2.750 109.5938 109.6250 0.0000 1.146

1/31/2018 2.625 108.7969 108.8438 -0.0313 1.169

2/15/2018 3.500 114.2188 114.2656 0.0000 1.167

2/28/2018 2.750 109.5781 109.6094 -0.0156 1.187

3/31/2018 2.875 110.3594 110.4063 -0.0469 1.202

4/30/2018 2.625 108.7813 108.8281 0.0156 1.223

5/15/2018 3.875 116.8438 116.8750 0.0313 1.211

5/15/2018 9.125 150.6250 150.6563 -0.0469 1.147

5/31/2018 2.375 107.0938 107.1250 -0.0156 1.255

6/30/2018 2.375 107.0469 107.1094 -0.0313 1.270

7/31/2018 2.250 106.1563 106.2031 -0.0313 1.297

8/15/2018 4.000 117.9219 117.9688 -0.0313 1.258

8/31/2018 1.500 101.1719 101.2188 -0.0313 1.315

9/30/2018 1.375 100.2031 100.2500 -0.0156 1.337

11/15/2018 3.750 116.4375 116.4688 -0.0156 1.316

11/15/2018 9.000 152.6563 152.7031 -0.0156 1.235

2/15/2019 2.750 109.4844 109.5156 0.0469 1.386

2/15/2019 8.875 153.1719 153.2031 0.0625 1.279

5/15/2019 3.125 112.2969 112.3594 -0.0313 1.407

8/15/2019 3.625 116.1094 116.1406 -0.0156 1.445

8/15/2019 8.125 150.0469 150.0938 -0.1406 1.379

11/15/2019 3.375 114.4688 114.5156 0.0156 1.470

2/15/2020 3.625 116.5469 116.5781 -0.0156 1.507

2/15/2020 8.500 155.2656 155.3125 -0.2344 1.451

5/15/2020 3.500 115.6563 115.6875 -0.1094 1.547

5/15/2020 8.750 158.1875 158.2188 0.0000 1.513

8/15/2020 2.625 108.2500 108.2969 0.0156 1.616

8/15/2020 8.750 159.3125 159.3594 0.0156 1.553

11/15/2020 2.625 108.1250 108.1563 -0.0781 1.657

2/15/2021 3.625 116.7813 116.8281 0.0156 1.675

2/15/2021 7.875 154.1563 154.1875 0.0469 1.615

5/15/2021 3.125 112.2813 112.3281 0.0469 1.727

5/15/2021 8.125 157.2188 157.2656 -0.0156 1.655

8/15/2021 2.125 103.0469 103.1094 0.0156 1.780

8/15/2021 8.125 158.1406 158.1875 0.0469 1.693

11/15/2021 8.000 157.9219 157.9688 0.0313 1.727

8/15/2022 7.250 152.8594 152.9063 0.0313 1.850

11/15/2022 7.625 157.3594 157.4063 0.0313 1.877

2/15/2023 7.125 152.7031 152.7500 0.0156 1.931

8/15/2023 6.250 144.4688 144.5156 0.0313 2.012

11/15/2024 7.500 161.4375 161.4844 0.1563 2.108

2/15/2025 7.625 163.6250 163.6719 0.1875 2.126

8/15/2025 6.875 155.8750 155.9219 0.2188 2.179

2/15/2026 6.000 145.9063 145.9375 0.2813 2.241

8/15/2026 6.750 156.4375 156.4844 0.2500 2.255

11/15/2026 6.500 153.7188 153.7500 0.2500 2.276

2/15/2027 6.625 155.9063 155.9531 0.2500 2.285

8/15/2027 6.375 153.5469 153.5781 0.2656 2.318

11/15/2027 6.125 150.4688 150.5000 0.2656 2.343

8/15/2028 5.500 142.8906 142.9375 0.2969 2.391

11/15/2028 5.250 139.4063 139.4375 0.2656 2.421

2/15/2029 5.250 139.7656 139.8125 0.2344 2.426

8/15/2029 6.125 153.3594 153.4063 0.2188 2.423

5/15/2030 6.250 156.5781 156.6250 0.1875 2.445

2/15/2031 5.375 144.1875 144.2188 0.1719 2.484

2/15/2036 4.500 133.0625 133.1094 0.2188 2.647

2/15/2037 4.750 138.0469 138.0781 0.1719 2.673

5/15/2037 5.000 143.1094 143.1563 0.1875 2.664

2/15/2038 4.375 131.2344 131.2813 0.1406 2.707

5/15/2038 4.500 133.8750 133.9063 0.2969 2.704

2/15/2039 3.500 114.5000 114.5781 0.1875 2.739

5/15/2039 4.250 129.4688 129.5000 0.2031 2.723

8/15/2039 4.500 134.5000 134.5469 0.0938 2.723

11/15/2039 4.375 132.1406 132.1719 0.0781 2.729

2/15/2040 4.625 137.3438 137.3906 0.0625 2.724

5/15/2040 4.375 132.4375 132.5156 0.1250 2.730

8/15/2040 3.875 122.3125 122.3594 0.0781 2.748

11/15/2040 4.250 130.0938 130.1406 0.0625 2.740

2/15/2041 4.750 140.5469 140.5938 0.0156 2.731

5/15/2041 4.375 132.9531 133.0000 0.0469 2.741

8/15/2041 3.750 120.0313 120.1094 0.0938 2.757

TREASURY BILLS Tuesday, October 04, 2011 Treasury bill bid and ask data are representative over-the-counter quotations as of 3pm Eastern time quoted as a discount to face value. Treasury bill yields are to maturity and based on the asked quote.

Maturity Bid Asked Chg Asked yield

10/6/2011 0.015 -0.005 0.0000 0.0000

10/13/2011 0.015 -0.005 0.0000 0.0000

10/20/2011 0.030 0.010 0.0050 0.0100

10/27/2011 0.015 -0.015 -0.0100 0.0000

11/3/2011 0.015 -0.005 0.0050 0.0000

11/10/2011 0.025 0.005 0.0150 0.0050

11/17/2011 0.015 -0.005 0.0050 0.0000

11/25/2011 0.025 0.005 0.0100 0.0050

12/1/2011 0.035 0.010 0.0200 0.0100

12/8/2011 0.035 0.015 0.0250 0.0150

12/15/2011 0.055 0.035 0.0450 0.0350

12/22/2011 0.070 0.050 0.0600 0.0510

12/29/2011 0.080 0.060 0.0650 0.0610

1/5/2012 0.015 0.005 0.0050 0.0050

1/12/2012 0.010 -0.010 -0.0200 0.0000

1/19/2012 0.015 -0.005 0.0000 0.0000

1/26/2012 0.040 0.020 0.0150 0.0200

2/2/2012 0.035 0.010 0.0100 0.0100

2/9/2012 0.025 0.005 -0.0050 0.0050

2/16/2012 0.025 0.005 -0.0050 0.0050

2/23/2012 0.025 0.005 -0.0050 0.0050

3/1/2012 0.025 0.020 -0.0150 0.0200

3/8/2012 0.025 0.020 -0.0150 0.0200

3/15/2012 0.035 0.010 -0.0050 0.0100

3/22/2012 0.030 0.020 -0.0100 0.0200

3/29/2012 0.035 0.025 -0.0150 0.0250

4/5/2012 0.040 0.035 -0.0100 0.0350

5/3/2012 0.050 0.040 -0.0150 0.0410

5/31/2012 0.065 0.045 -0.0050 0.0460

6/28/2012 0.070 0.060 -0.0050 0.0610

7/26/2012 0.085 0.070 0.0000 0.0710

8/23/2012 0.090 0.085 -0.0150 0.0860

9/20/2012 0.105 0.080 0.0050 0.0810

FEDERAL AGENCY SECURITIES

As we have studied debt (bonds) issued by corporations, and the U.S. [Federal] Government, there are agencies of the Federal Government that are for-profit, stock-held corporations, given charters by the Government to operate.

These agencies provide a valuable service to the financial industry called Securitization. This is the act of making an investment security out of something that isn't; and in doing so, they bring liquidity to financial firms.

This is how it works: Banks and other financial institutions loan money as one of their primary sources of income. The central problem with lending is that banks would prefer to lend in the short term, but much of their business is comprised of mortgage loans with 30-year maturities. The bank funds these long-term loans with short term deposits (people do not commit themselves to 30-year deposits). This mismatch between assets and liabilities is one of the largest mistakes that a financial institution can make. The bank is concerned about interest rate risk. The risk that interest rates will rise, moving the rate on short-term deposits up beyond the rate the mortgage loan is earning.

Imagine that the savings rate is 3% and the mortgage rate is 6%; so far, so good, the bank makes the difference (the spread) between the two rates. Now imagine that interest rates rise to 7%, now the bank is paying 7% on deposits and the mortgage loans (signed for 30 years) continue to pay 6%. The bank is losing 1% on every dollar of deposit......we called this the Savings & Loan crises in the 1980's.

The bank uses federal agencies to minimize the interest rate risk that is inherent in mortgage lending.

Let's say that a bank makes $1,000,000 of mortgage loans today. Because the loans are made at a similar period of time, the interest rate on the loans are usually similar, say 6.5% in today's market.

The bank will immediately sell the loans to federal agency The Federal National Mortgage Association (FNMA, called "Fannie Mae") to minimize the interest rate risk and to bring the million dollars back to the bank to make more loans. Fannie Mae will form a "pool" with these loans and slice the "pool" into slices, $25,000 per slice. In our example, imagine a million dollar pool cut into 40, $25,000 slices. The slices are sold to the investing public as bonds.

Investors that are interested in bonds are many times attracted to these Mortgage Backed Securities. They pay a higher rate of interest than many other debt securities, have 30-year terms and are backed by a Federal Agency (FNMA).

Fannie Mae, is called a pass-through agency. The loans pass from the banks through FNMA to the investor. As people make their mortgage payments, the money passes to the bondholder (principal and interest).

Other federal agencies are:

The Government National Mortgage Association (GNMA, Ginnie Mae) who securitizes mortgages, just like Fannie Mae.

The Student Loan Marketing Association (SLMA, Sallie Mae) who securitizes government guaranteed student loans.

If there is a particular problem with these types of investments is that the investor is now taking the interest rate risk. You "get paid when you least want to." Financial institutions are protecting themselves from interest rate risk (the largest single risk in investing in fixed income securities) by selling the bonds.

Let's say that you own a mortgage bond at a current rate of 6.5%. If interest rates rise to 7.5%, you want to invest at the new, higher rate but your payments will come in slowly; your payments are dependent on the person that holds the mortgages. When interest rates increase, they do not pre-pay their mortgages but hold them for as long as they can.

If interest rates fall to 5.5%, people refinance their homes for the lower interest rate and PAY OFF the 6.5% loan. That means that the bond holder of the 6.5% mortgage is paid off long prior to maturity.

12/29/16

THE TERM STRUCTURE OF INTEREST RATES (YIELD CURVE)

The hypothetical yield curve is a "line-of-best-fit" drawn through different interest-maturity combinations. The curve forms a graphical picture of market interest rates at any given time.

The Yield Curve (or the "Term Structure of Interest Rates") is a graphical relationship of interest rates and terms of maturity for fixed income products.

A "typical, normal" yield curve is a graph that is upward sloping, to the right.

If there is a picture "worth a thousand words" it would be a yield curve. So much is said about the condition of the economy and the market by the shape of the Curve.

Some particulars about the Yield Curve:

The Treasury Yield Curve is pictured in the Wall Street Journal daily. The United States Treasury 'sets the curve.' Whenever the US Government borrows

money, the bonds, notes and bills are auctioned usually to large banks and brokerage firms. The price and yield that wins the auction sets the rate.

Corporations that need funding through a bond issue look to the Treasury Yield Curve to determine what they have to pay for money. They can't pay lower than Treasury, their bonds would not sell (investors would not consciously buy a General Electric bond that paid 5% if the comparable Treasury paid 5 1/4%).

The interest rates that a company pays for money is largely determined by their credit rating. The lower the credit rating, the higher interest rates that they have to pay. We

measure risk in the curve vertically; as credit ratings get lower (worse), the yield curve is higher above the Treasury curve.

We also measure risk horizontally; the spread between the rate on the left side of the curve versus the rate on the right side of the curve, signals what the market thinks of inflation and future rates. In the curve above, the near-term rate is right about 2.25%; the long-end of the curve is at a rate of about 5.4%. There is a 3.15% spread between the two. The larger the spread, the steeper the curve. A steep curve tells us that the Market believes that higher interest rates are in our future, that interest rates in the future will increase. A relatively flat yield curve has a small spread and indicates that the Market believes that interest rates will remain relatively unchanged, that inflation is under control and will not soon increase.

There are examples of INVERTED yield curves below. These point to a recession, short-term rates are higher than long-term rates. In these instances financial institutions curtail their lending or refuse to lend increasing the change for recession.

Every recession was preceded by an inverted yield curve.

Three Theories on the shape of the YIELD CURVE

Rational Expectations Theory: (The easiest, most strait forward of the theories) This theory states that investors expect to be paid a higher interest rate when investing for a longer term. This is the most plausible, most referenced theory of the yield curve's shape. To "go out on the curve" means purchasing longer termed securities and to do so invites more risk.

Liquidity Preference Theory: [A little tougher to understand] An investor will sacrifice a higher yield for a lower yield by lending short term instead of long term. An investor will pay a higher price (and accept a lower yield) to have a shorter term, more liquid security. Thus a 'liquidity preference.'

Market Segmentation Theory: {The toughest one} This theory asserts that the yield curve is not smooth and continuous but exists as broken segments, each with their own set of terms and rates. Businesses operate in certain areas of the curve. Banks, for example, tend to prefer to lend money short term, and borrow short term. Insurance companies have products (like life insurance) that are primarily long-term in nature, other companies tend to buy and sell securities in the "middle" of the curve. Market Segmentation states that the "segments" are independent of each other.

Some YIELD CURVE comparisons

This is a picture of a yield curve from June of 2000; the inverted shape is NOT a normal curve. EVERY recession began with an inverted yield curve and this situation was no exception, this curve was right before the recession of 2001.

Same curve as above, but one month later...July, 2000.

10/13/19

BOND PROBLEMS

What is the dollar price of a corporate bond with a quotation of:

Quotation Answer

86 $860

103 1/8 $1031.25

91 5/8 $916.25

111 15/16 $1119.38

106 $1060

100 $1000

55 5/8 $556.25

27 13/16 $278.13

99 $990

152 3/8 $1523.75

Given the following bond listings, find the requested information:

ATT 6 1/8

A) Find the coupon yield 6.125%

B) Find the Current Yield if the bond price quote is 106. 5.778%

C) Find the Yield-to-Maturity if the price quote is 106, with 6 years to maturity.

4.9757%

D) Find the Yield-to-Call if the price quote is 106, it can be called at 103.5 in 2 years.

4.6539%

Stone Container 10 1/2

A) Find the coupon yield. 10.5%

B) Find the current yield if the price quote is 104.5 10.047%

C) Find the Yield-to-Maturity if the the price quote is 104.5 with 22 years to maturity.

10.0689%

D) Find the Yield-to-Call if the price quote is 110, it can be called for 101 in 7 years.

8.7339%

Exxon 8 3/4

A) Find the coupon yield. 8.75%

B) Find the current yield if the price quote is 99. 8.838%

C) Find the Yield-to-Maturity if the price quote is 99 with 15 years to maturity.

8.8609%

D) Find the Yield-to-Call if the price is 101, it can be called at 103 in 2 years.

9.5588%

Qualcomm 7 7/8

A) Find the coupon yield. 7.875%

B) Find the current yield if the price quote is 97 3/4. 8.056%

C) Find the Yield-to-Maturity if the price quote is 96 5/8 with 20 years to maturity.

8.1818%

D) Find the Yield-to-Call if the price quote is 98, it can be called at 101 in 6 years.

8.41708%

BOND VALUATION PROBLEMS

Find the price of a 10% coupon bond with 10 years to maturity if interest rates:

A) increase by 1% $940.25

B) decrease by 1% $1065.04

C) increase by 1.5% $912.20

D) decrease by 1.5% $1099.71

Find the price of an 8% coupon bond with 30 years to maturity if interest rates:

A) increase by 3/4% $920.85

B) decrease by 3/4% $1091.24

C) increase by 1 1/4% $873.83

D) decrease by 1 1/4% $1159.91

Find the price of a $1000, 8% zero coupon bond with 10 years to maturity. (Use semi-annual compounding) [$456.3869]

Find the price of A $1000, 7 1/2% zero coupon bond with 30 years to maturity. (Use continuous compounding)[$105.399]

Find the value of a $10,000, 6 1/8% Treasury Bill with one year to maturity. (Use continuous compounding)[$9405.88]

Finance 2302 - Sample Exam for Bonds & Fixed Income Investments

T F 1. A call provision allows the corporation to retire a bond before maturity by paying a small discount below par value.

T F 2. The IRS taxes zero coupon bonds as if interest were paid semiannually even though no cash flow is received until maturity.

T F 3. An important feature of the GNMA pass-through certificate is that there is no principal balance at maturity.

T F 5. Like the stock market, there is a strong secondary market for bond issues, particularly corporate bonds.

T F 6. The major provisions in the bond agreement are spelled out in the bond indenture.

T F 7. A secured corporate bond is referred to as a debenture.

T F 8. A Treasury bill is a long-term obligation of the federal government.

T F 9. The Federal Reserve Board of Governors controls money supply and interest rates through its monetary policy.

T F 10. The higher the bond rating of a corporation, the higher the interest rate that is likely to be paid.

T F 11. Money market funds represent a vehicle to buy short-term fixed-income securities through a mutual fund arrangement.

12. Which of the following types of bond issues are the most price sensitive?

A) Fixed rate long-term bonds B) Floating rate bonds C) Zero coupon bonds D) Fixed rate short-term bonds

14. Junk bonds normally provide

A) a higher yield than treasury bonds B) a lower yield than treasury bonds C) a lower yield than AA corporate bonds D) more than one of the above is true

15. A call feature may be valuable to:

A) Investors

B) the issuing company C) corporate employers D) the IRS

16. Corporate bonds generally trade in units of

A) $100 B) $1,000 C) $5,000 D) $10,000

Answer Key – Bond Fundamentals

1. False 2. True 3. True 5. True 6. True 7. False 8. False 9. True 10. False 11. True 12. C 14. A 15. B 16. B