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Bond Markets Defined______4 TABLE OF CONTENTS Table of contents_________________________________________1 Dedication_____________________________________________3 What are bonds _________________________________________4 Bond Markets Defined_________________________________________________4 Corporate Bond ______________________________________________ _______7 Corporate bonds distinct from common stock______________________________8 Types of Corporate Bonds _________________________________9 Corporate Bond Information and Features______________________10 Bond indentures:____________________________________________________10 Prospective covenants:_______________________________________________11 Bond valuation_____________________________________________________11 Broad categories of corporate debt:___________________________11 Corporate bond credit rating:___________________________________________13 Methods of Investing ____________________________________13 Risk analysis__________________________________________1 4 Corporate bond indices___________________________________15 External links__________________________________________16 Comparison to corporate bonds_____________________________17 Default Rates__________________________________________17 1 How Big Is the Market, and Who Buys?_________________________19 How Corporate Bonds Are Taxed_____________________________20 Guide to Making the Most of Corporate Bonds:____________________21 _ Benefits of Investing in Corporate Bonds______________________23 Bond Funds___________________________________________24 Event Risk Mitigation (Special Features)____________________________26 conclusion____________________________________________28 2 This report is dedicated to my respected teachers. What are bonds? 3 A bond is way of describing a company or government borrowing money - they are a form of IOU. Investors lend money to a company for a fixed period and it pays them a return for doing so. In recent years, returns from bonds have been very poor; often paying less than you could get on a good savings account. A year ago, a cursory glance at the performance tables for UK corporate bond funds revealed that not a single portfolio, available to small investors, had made money in the previous 12 months. But the tide has turned and experts are seeing strong reasons to invest. Jonathan Brown low of City wealth management group, The Route, adds: 'Yields are very attractive on corporate bonds but people are still less confident putting money with institutions – especially in the light of what's happened at Northern Rock – credibility is in tatters. But having exposure to corporate bonds in any investment portfolio is very important – it diversifies assets.' The reason for the turnaround for corporate bonds is largely due to the credit crunch. Firms are willing to borrow money from bond buyers rather than banks, because banks are being ultra-cautious in terms of lending at the moment. So to encourage bondholders, companies are offering them more attractive returns. Bond Markets Defined ● Municipal Securities Market ● Treasury Securities Market ● Federal Agency Securities Market ● Corporate Bond Market ● Money Market Instruments ● Mortgage Securities Market ● Asset-Backed Securities 4 Municipal Securities Market Municipal securities are debt obligations issued by states, cities, counties, and other governmental entities to raise money to build schools, highways, hospitals, and sewer systems, as well as many other projects for the public good. Municipal securities are the most important way that U.S. state and local governments borrow money to finance their capital investment and cash flow needs. An important distinguishing characteristic of the municipal securities market is the exemption of interest on municipal bonds from federal income taxes. The implicit subsidy provided by the federal government permits municipal issuers to compete effectively for capital in the domestic securities market. There is currently in excess of $1.8 trillion in outstanding municipal debt, comprising obligations of approximately 50,000 issuers. Treasury Securities Market The U.S. Treasury securities market is the largest and most liquid market in the world. There is currently $3.1 trillion in outstanding marketable Treasury debt. The U.S. Treasury issues three types of securities: bills, which have a maturity of less than 1 year; notes, which have a maturity of 2 to 10 years; and bonds, which have a maturity of greater than 10 years. Federal Agency Securities Market Federal agency debt is issued by various government-sponsored enterprises (GSEs) which were created by Congress to fund loans to borrowers such as homeowners, farmers and students. Through the creation of GSEs, the government addressed various public policy concerns about the ability of members of these groups to borrow sufficient funds at affordable rates. Most GSEs rely primarily on debt financing for their day-to-day operations. Among the most active issuers of agency debt securities are: Federal Farm Credit System Banks, Federal Home Loan Banks, Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), Student Loan Marketing Association (Sallie Mae) and Tennessee Valley Authority (TVA). There is an estimated $2.3 trillion in agency debt currently outstanding. 5 Corporate Bond Market Corporate debt securities are obligations issued by corporations for capital and operating cash flow purposes. Corporate debt is issued by a wide variety of corporations involved in the financial, industrial, and service-related industries. There is approximately $4.0 trillion in corporate debt currently outstanding. Money Market Instruments Money market instruments include banker’s acceptances, certificates of deposit, and commercial paper. Together these three instruments account for an estimated $2.5 trillion in outstanding instruments. Banker’s acceptances are typically used to finance international transactions in goods and services, and currently represent an estimated $5.2 billion market. Certificates of deposit (CDs) are large denomination negotiable time deposits issued by commercial banks and thrift institutions, representing about $1.2 trillion. Commercial paper, which is short term unsecured promissory notes issued by both financial and non-financial corporations, is currently a $1.3 trillion market. Mortgage Securities Market Mortgage securities represent an ownership interest in mortgage loans made by financial institutions (savings and loans, commercial banks, or mortgage companies) to finance the borrower's purchase of a home or other real estate. Mortgage securities are created when these loans are packaged, or "pooled", by issuers or services for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal. The majority of mortgage securities are issued and/or guaranteed by an agency of the U.S. Government, the Government National Mortgage Association (Ginnie Mae), or by government-sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Some private institutions, such as subsidiaries of investment banks, financial institutions, and home builders, also package various types of mortgage loans and mortgage pools. The securities they issue are known as "private-label" mortgage securities, in contrast to "agency" mortgage securities issued and/or guaranteed 6 by Ginnie Mae, Fannie Mae, or Freddie Mac. There is an estimated $4.0 trillion in outstanding agency mortgage securities, with an additional $584 billion in outstanding private label mortgage securities debt. Asset-Backed Securities Asset-backed securities (ABS) are certificates which represent an interest in a pool of assets such as credit card receivables, auto loans and leases, or home equity loans. The interest and principal payments on the pool of assets are passed through to investors, typically institutional, who invest in highly rated, short-term liquid assets. The ABS market has expanded rapidly in the past several years and there is approximately $1.5 trillion in debt currently outstanding. Corporate Bond A Corporate Bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business.a corprate bond is a security issued by a corporation that represents a promise to pay its bondholders a fixed sum of money at a future maturity date,along with the periodic payments of debt.the fixed sum paid at maturity is the bond’s principal also called its par or face value.the periodic interests are called its coupons. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category. Corporate bonds are often listed on major exchanges (bonds there are called "listed" bonds) and ECNs like MarketAxess, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, 7 despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based,
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