Bonds and Debt: A Crash Course

Crash Course in Bonds and Debt

Introduction

• It focuses on debt analysis
• Demand for debt comes from governments, corporations, and households
• Debt securities are fixed-income financial instruments that require borrowers to pay security holders a predetermined amount for upfront capital
• Unlike equity investors, debt securities allow the issuer to pay a predetermined amount to the holder of the security
• The value of the debt market is $199 trillion, dwarfing the value of global equity
• Two broad types of debt are loans and bonds; Bonds are actively traded, while loans are generally not traded
• Governments borrow using bonds, while households borrow using loans
• Corporations borrow using both bonds and loans
• Investors (lenders or creditors) provide capital to institutions through banks and underwriters, and receive certificates with interest and principal payments

Credit Type

• Credit type varies across countries. For non-financial firms, bank lending is only the majority of credit in Germany
• The US is the most heavily weighted towards corporate bonds.

Global Debt Allocation

• 46% of non-US debts are from developed countries
• The US dominates world debt
• United States: 40%
• Non-US Developed: 46%
• Emerging Market: 14%

Bond Basics

• If you require a $10,000 loan, you must pay $600 interest every year (at year end) for five years, plus $10,000 at the end of year five
• If you receive $13,382 five years from now in exchange for giving me $10,000 today, a zero coupon bond, with no coupons is created
• Compare offers using return rates; the return, or (r), is called a yield (y), or the interest rate (i)
• The bullet bond has three other names, the bond, bullet bond is also known as the conventional, or vanilla bond
• Zero-coupon bond along with annuities (the lender receives payments back with interest), are other bonds
• Notes are bonds with short maturities
• Nominal rate, or yield (with the $ coupon and/or face value), is usually paid semi-anually

Zero Coupon Bond Return

• Total return = (FV / PV) -1
• Annual return (y) = (FV/PV)^(1/N -1 number of years

Bond Pricing Formula

• Price of bonds = multiple annual cashflows
• T = final year. Solve for y (trial and error / use Excel =RATE())
• Finding yield (y) is trial and error
• Finding PV (price today is summing present value of each interest payment plus PV (discount))
• By taking offer 1 (with coupons), reinvesting at identical yield you will arrive at 13382

Reinvesting

• All money is equivalent from a coupon prospective

Annuity

• The bond commingles interest and principal with equal payments in each period
• There is no additional principal payment for discounts
• It is mainly insurance firms
• With Excel's =Rate() comes a FV of 0 and a yield of 6% same as 1/2

Yields

• Singular form for the rate from the course has been the Yield to Maturity, or YTM
• YTM is IRR for singular interest to compare similar bonds

YTM, Current and Nominal Yields

• Nominal yield = (coupon / par value)
• Current yield = (coupon / bond price)

• YTM takes into account
  

•  Coupon payments
  

•   Assumes reinvestment at same rate
  

•   Time to maturity
  

• Unlike YTM, the current yields don't capture recovery or reinvestment
• Shorter term govt bonds are zero coupon

Key Concepts

• Three-year T-Bill
• Annuity is common, (mortgages/retirement)
• You select bullet structure- demand higher yield, then takes less offer #1

Bond Details

• Banks price value, as well as other fees Underwriters:
• charge percentage of par value
• additional fee for accounts (AIC)
• Borrower’s - percent cost, is known as AIC- Borrower’s will charge the underwriter fee
• You keep the other lower amount, which brings AIC - to high percentage
• Finding YTM- called notes- bonds usually valued in 1000 denominations
• If a bond is greater in place than the par value, then is at premium
• If a bond is lesser inplace than pa value, then is at discount
• Banks priced by fees
  • Fee are calculated from bar value

Bond Prices

• They are rounded in percent and / or % are dropped for short

• 98 is the handle, basis points or bps. 1 bps is 1/100
  

• Corporate bond prices are rounded .32- .375

  • Government- one/ thirty seconds, and ie-101
    

Interest Rate

• Coupon payments and frequency, determine S/A payments from rates
  • Quarterly or monthly, how to gauge respective attractiveness
  • YTM- various and conflicting
  • S/A. YTM from 4%- will be used in the year

YTM / Yields

• Bond Equivalent Yield: (BEY): -Annualize the period Yield, the conversion called
• BEY = Coupon Period
• YTM * Coupon per year

Basic Bond Concept

• Offers need to be converted- all into zero coupon
• Understanding conceptual framework- will help you- all these yields by calculations

BEY

Effective annual field- true Annual YTM is converted by compounding -

• BEY is the most common way that bond yields are discussed

Bonds

• US Govt Bonds- are Short Term- B Bills,
• Annuity- mortgages-

Money Market

• One common- interest rates, is calculated- assumed by 360 day
• Another- you might thank you pay- with interest quoted
• Another- is broadly- speaking by a day from formula
• Known rates- quoted interests "money market yield

Conventions

-MMY- interest is quoted for

• CDS
• FEDERAL funds
• REPOS
• OTHERS Libor linked
  • Certain instruments- us treasury bills and commercials paper
  • Discount- FV

Price

• Yields and bonds, move in opposite directions

Relationship

• Key takeaway: the bonds' product and value has a yield direction
• Also, it doesn't always relate relationship of price, in linear
• A bond is tried sell- has very liquid, as a sometimes yield, the price- you can charge

Relationships/Formulas

• Bond with variable payments (annuity)
• Finding values, is most trail and error- find by excels
• Formula 2: is easier total return can be calculated Total return- fv -1 /pv

Bond Issuance

• If the bullet structure demands a higher YTM- will only give 6% because you feel isn't a higher yield
• Take less up from your number to get don't - What's the most willing to give in interest-payments
• After it's calculated interest, and return.

Before Continuation of Notes

• There are three common notes
• Bulleted
• Zero coupon notes
• Annuity

Calculations

• Zero coupon bond- easier to sell
  • Total return - calculated / from PV- I
  • For the second offered coupon -
  • Annual return Y-

Yield Calculations

• BEY ignores reinvestment
  • But, while is close -Isn't the true annual YTM- for Bonds- where-Coupon is greater than Annual bonds
  • Coupon is received - and reinvested at YTMs" the Annual return

EAY -Earning

• True Annual YTM- arrive at compounding period- Earning- 1+ coupon- bonds periods-

Yield Calculations continued

• We're- Going to be the Precise rate used in the Current and period- and
• Bloomberg and Martinster reffered -BEY- The formula has two equations

Yield Calculation for Bond Coupons

• Yield (IRR)- you know how to coupon and payments so we are in convert- and to a point

Before Continued Bonds

• Bond prices are- notes- and % rates of value. Value, is shown more often- bonds

Formulas

• Coupon Bonds- value that they get in the periods + discount

• Annuity- is the value to find-

• Zero coupon bonds- Fv - PV = FV / pv1/z

• Arranged PV- FV / L+YT

Global Economics & Yields

•   Bigger effect- what they are from- how to set
  

Key facts

• They take the coupon rate of the YAS with bonds- they're also shorted- which equals a 1.322

Coupon Math

• Money is often from CDS
• Some bands- for coupon you will see a shift
• Yield- was converted for coupon rate What is it MMY- you may also hear- discount bases- bonds

Basic Bond Principles & Calculations

• The loan / transaction is direct relationship / market
• When short, what lenders already trade- to themselves
• Bid / Ask- doesn't need to directly buy- seller in bonds

Conventions in Bond Markets

• The higher the credit level- the lower amount is needed to do
• The spread - is determine by-the higher bonds in that point + 4 CS
• The market- that get to credit level