Understanding Premium Bonds

Size: px
Start display at page:

Download "Understanding Premium Bonds"

Transcription

1 Understanding Premium Bonds Many individual investors prefer to purchase individual bonds at prices around par value (100), or even at a discount to par. With interest rates hovering near historic lows, this presents a challenge for these investors as most individual bonds issued over the prior few decades carry higher than market coupon rates, causing them to trade at high premiums in the secondary market (often at prices of 110 or more). As we will attempt to illustrate in this commentary, the dollar price of a bond should not be the sole determinate in evaluating its attractiveness in any type of buy/hold/sell decision. In fact, higher premiums that are typically associated with higher coupons may in fact provide a degree of protection in a rising interest rate environment, vis-à-vis a par or discount bond. Given today s challenging fixedincome environment, it may be of particular value for investors to explore this issue with the goal of overcoming a psychological barrier which may be unfairly coloring investment decisions. For the sake of simplicity, we will focus on federally tax-exempt municipal bonds. Premium Bond Definition A premium bond, as it is generally defined, is a bond trading at price higher than its par value (typically, a price of 100, or face value of $1,000 per bond). Because bonds are typically issued with a fixed coupon, as the interest rate environment changes over time, the price of that bond will also change to reflect current market rates. For instance, current new issue AAA rated 10-year municipal bond rates are around 2.50% (Source, Bloomberg L.P. 6/10/14). There may be a bond outstanding that was issued 20 years ago and now has 10 years left to run carrying a coupon rate of 5% (due to interest rates being much higher 20 years ago vs. today). If today s 2.5% coupon bond is trading at par (100) to reflect current market rates, then the 5% coupon bond that has 10 years left to maturity must be trading at a price higher than par, in order to bring that bond s prospective return in line with the current 2.5% market rate. In fact, a 5% coupon non-callable bond 10-years long priced at 2.50% yield to maturity would have a price of around $122, a significant premium above par value. This concept leads us to explore other ways to measure a bond s attractiveness in the marketplace, rather than simply looking at price alone. Yield to Worst Yield to worst is a measure of the minimum annualized return an investor can expect to achieve when purchasing a bond at a given price, with a given fixed coupon rate, maturity, and stated call provisions. Of course, this calculation assumes the bond does not default, and the investor holds the bond to call or maturity date. We believe this is a much better way of determining the attractiveness of a buy/hold/sell decision. This calculation takes into consideration both the fixed coupon rate, as well as the price you pay/receive for the bond s purchase/sale. For non-callable bonds, the yield to worst would be the

2 bond s yield to maturity. For callable bonds priced at a premium, the yield to worst will most often be the yield to call. For callable bonds priced at a discount to par, the yield to worst will typically be the yield to maturity. For callable bonds, it is important to consider both the yield to call and yield to maturity when making a buy/hold/sell decision. Importantly, because many investors do not understand the concept of paying premiums for municipal bonds, bonds priced closer to par tend to be in higher demand. Due to the well known laws of supply and demand, higher demand for par-type bonds can place upward pressure on the bond s price, resulting in lower yield (the yield and price of a fixed-coupon bond move inversely). Therefore, investors may be able to purchase higher premium bonds at a lower price (higher comparative yield) versus a partype bond with similar characteristics, all else being equal. Let s explore this concept by way of a purely hypothetical example. Examine the two bonds and scenarios listed below. This example is for illustrative purposes only, and is not a recommendation to buy, sell, or hold either of these securities. Bond 1: Hillsborough County FL School Board 5% coupon, matures 7/1/19, non-callable, trading at a 1.70% YTM, for a price of about for settlement on 7/15/14. Source: Bloomberg, LP.

3 Bond 2: Tulsa County OK School Dist #1 2% coupon, matures 7/1/19, non-callable, trading at 1.50% YTM for a price of about for settlement on 7/15/14. Source: Bloomberg, LP. In an effort to illustrate this concept and for the sake of simplicity, let s assume these two bonds are roughly identical (ignore the qualitative differences such as geographic location, ratings, etc. for this particular exercise) with the exception of a) the coupon, and b) the yield/price in which they are trading. Note that the higher premium Hillsborough bond as shown in this hypothetical example could be purchased at a 1.70% YTM vs. a 1.50% YTM on the OK bond, reflecting the potentially lower demand / higher yield that may be possible as mentioned previously. Now, let s examine the cash flows of these two bonds between now and final maturity, using the YTM s as listed above:

4 Bond 1: Hillsborough yield and cash flow analysis. Source: Bloomberg, LP. Bond 2: OK yield and cash flow analysis. Source: Bloomberg, LP.

5 Box 1 in both examples points to the bond s price, which determines the yield to worst (in this case, yield to maturity) as noted by box 2. Box 3 shows how much the total cash outlay would be to purchase 25,000 face value of each bond. Note the premium priced Hillsborough bond will cost $28, vs. $25, for the lower priced Tulsa bond, or $3, more. Given that both bonds will return $25,000 upon maturity (assuming no default), how could the higher priced Hillsborough bond potentially be a better deal? Reviewing the information highlighted by box 4 helps to illustrate just that. As listed, both bonds will return $25,000 in principal upon maturity, again assuming no default. However, note the much higher coupon payments received over time by the Hillsborough bond. Doing a simple calculation of the total income received in Box 4 minus the total amount paid for each bond in Box 3 provides $2, for the Hillsborough and $1, for the Tulsa, or a difference of $ over the life of the holding. Quite simply, the higher premium bond in this example has the potential to deliver a higher return to the investor, as is not readily apparent by simply looking at the price or initial cash outlay. An important point to note: As is normal convention in bond arithmetic, the yield to maturity/yield to worst calculation assumes all coupon payments are reinvested at the same rate over the life of the bond. A lower reinvestment rate may lower the return, while a higher reinvestment may raise the return. This is often referred to as interest on interest. For this example, as you can see in the 3 rd line of box 4 titled we have set both reinvestments to 0%. This would be as if the coupon payments earned would simply go to cash earning a 0% return. This penalizes the premium Hillsborough bond somewhat given that interest on interest for this bond would theoretically be higher than the Tulsa bond. However, this helps to keep the illustration simple and is a more conservative measure of the comparison. Understanding Amortization It is a common misperception that the loss associated with buying a bond at a premium and having it mature or be called at a lower price is an unequivocal negative. Investors are conditioned to buy low, sell high. It would appear in this case you are buying high, and selling low. However, what is often forgotten is the fact that the investor is earning a higher than market coupon rate from the time of purchase to either call or maturity date (as illustrated above). This higher than market coupon rate, assuming the investor purchased at a higher yield to worst versus a comparable par bond, may more than makes up for the loss associated with a premium purchase. With a tax-exempt municipal bond purchased at a premium to par, the difference between purchase price and par (or call price, if the bond is callable) is amortized each year, or reduced by a specified amount (based on IRS rules) such that upon call or maturity date, the amortized price equals maturity or call value, resulting in no gain or loss. If the bond is sold prior to call or maturity, there may be a reportable gain or loss depending upon how the sale price compares to the then current amortized value.

6 It should be noted that this may not be the case with bonds other than tax exempt municipal bonds. As is typically the case, amortization of a federally taxable bond held in a taxable account may be a direct write-off to income for the year. It is important for us to state that this and any discussion of amortization or other tax related issues is for general informational purposes only, and should not be taken or misconstrued as tax advice. Please consult your tax professional for all matters related to the taxation of your investments. Premium Bonds in a Rising Interest Rate Environment The term duration is a measure of a bond s price sensitivity (the value of principal) to changes in interest rates. Duration is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. Put simply, if a bond s duration is 4 years, that bond s price will change by approximately 4% for every 1% move up or down in interest rates. Because premium bonds deliver higher cash flows to the investor (in terms of the higher coupon received), a higher percentage of the returns come over a shorter period of time as compared to a lower coupon bond. This results in the premium bond having a lower duration when compared to the lower premium, par, or discount bond (all else being equal). This lower duration potentially results in a bond holding that drops less in price as interest rates rise. Given the current interest rate environment, bond holdings which may drop less in price as interest rates rise may be of particular interest to fixed-income investors, especially if they may also be purchased at a potentially lower price / higher yield vs. par-type bonds. Another possible advantage to owning higher premium bonds comes from a tax quirk with respect to how tax exempt municipal bonds trading at a discount to par value may be taxed. As stated previously, individual tax free municipal bonds purchased at a premium to par value are not taxed at the federal level if held to maturity or call. However, certain tax free municipals purchased at a discount to par value could have part of the difference between purchase price and par value taxed at ordinary income rates. In the case where part of this return is taxed, an investor would have to receive a commensurately higher yield in order to equate the after tax yield on the discount bond with that of a completely tax free premium bond. As interest rates rise and bond prices drop, this tax on discount bonds can become greater and greater, causing that bond s price to drop faster than that of a comparable premium bond. Due to this technical factor with respect to taxes and bond pricing, it may be beneficial in terms of portfolio pricing and returns to focus more on premium bonds with a lesser chance of trading at large discounts to par value. Of course, if bonds are held to final maturity or call date, this issue becomes less relevant. In our view, it is likely more of an issue with regard to short term performance and valuation metrics, or if an investor is forced to liquidate a bond prior to maturity date. Risks Associated With Premium Bonds Because premium bonds most often carry a higher than market coupon/interest rate, they may be more likely to get called. This higher degree of call risk can be detrimental to an investor from the perspective of having to reinvest the called bond s proceeds at potentially lower

7 interest rates. This is why yield to worst as outlined above is an important concept, as an investor can compare the expected returns to a given call date versus that of par priced bonds. In the rare case of a default, the recovery rate, or the amount of money you receive back from the defaulted entity, is typically constant across a specific class of bond holders. This recovery rate is uniform irrespective of what you paid for the bond. So if the recovery rate for a defaulted bond is 80 cents on the dollar, the investor who paid par (100) for the bond may have a higher overall return (or less negative return, depending) than the investor who paid a higher premium. As stated previously, higher premium bonds may trade cheaper in terms of higher yields due to the somewhat lower retail demand. Buying cheap may also mean selling cheap. While many investors purchase individual bonds with the idea of holding them to final maturity or call date, it is possible circumstances arise which may force an early sale of a bond holding. Higher premium bonds may sell for a lower price than a comparable par-type bond, using the same supply/demand logic as previously mentioned. Additionally, and as with all bonds, there are additional risks which should be considered. These include default (credit) risk, interest rate risk, and market risk. In today s complex fixed-income markets, we strongly believe individual investors may benefit from working with a skilled fixedincome manager. Conclusion Premium bonds may be misunderstood by some individual bond investors. Often times, this may result in lower demand for these securities vis-à-vis bonds trading closer to par value with similar characteristics. This may provide investors with the potential opportunity to find higher returns in terms of yield to worst / yield to maturity. There are other possible benefits as well, with regard to the possibility of lower price volatility in a rising rate environment. As with all securities, certain risks are present and should be explored and understood before making any buy/sell/hold decisions. As always, if you have further questions, comments, or inquiries regarding premium bonds, or any other fixed-income related matters, please speak with a member of our team who can assist you.

Municipal Market Focus

Municipal Market Focus Municipal Market Focus New Issue Premium Coupon Bonds The nuances of bond pricing the relationship between yield, coupon, premiums, and discounts can be confusing to many investors, but understanding some

More information

Bonds, in the most generic sense, are issued with three essential components.

Bonds, in the most generic sense, are issued with three essential components. Page 1 of 5 Bond Basics Often considered to be one of the most conservative of all investments, bonds actually provide benefits to both conservative and more aggressive investors alike. The variety of

More information

Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk

Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow

More information

CHAPTER 14: BOND PRICES AND YIELDS

CHAPTER 14: BOND PRICES AND YIELDS CHAPTER 14: BOND PRICES AND YIELDS PROBLEM SETS 1. The bond callable at 105 should sell at a lower price because the call provision is more valuable to the firm. Therefore, its yield to maturity should

More information

Floating-Rate Securities

Floating-Rate Securities Floating-Rate Securities A floating-rate security, or floater, is a debt security whose coupon rate is reset at designated dates and is based on the value of a designated reference rate. - Handbook of

More information

Tax rules for bond investors

Tax rules for bond investors Tax rules for bond investors Understand the treatment of different bonds Paying taxes is an inevitable part of investing for most bondholders, and understanding the tax rules, and procedures can be difficult

More information

Calling the Calls on Municipal Bonds And How To Use Calls To Seek Higher Yields

Calling the Calls on Municipal Bonds And How To Use Calls To Seek Higher Yields Calling the Calls on Municipal Bonds And How To Use Calls To Seek Higher Yields Investors can get hurt by bond calls, particularly when they buy premium bonds without knowing all the calls in advance.

More information

Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23.

Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23. Chapter 8 Bond Valuation with a Flat Term Structure 1. Suppose you want to know the price of a 10-year 7% coupon Treasury bond that pays interest annually. a. You have been told that the yield to maturity

More information

CHAPTER 14: BOND PRICES AND YIELDS

CHAPTER 14: BOND PRICES AND YIELDS CHAPTER 14: BOND PRICES AND YIELDS 1. a. Effective annual rate on 3-month T-bill: ( 100,000 97,645 )4 1 = 1.02412 4 1 =.10 or 10% b. Effective annual interest rate on coupon bond paying 5% semiannually:

More information

Alliance Consulting BOND YIELDS & DURATION ANALYSIS. Bond Yields & Duration Analysis Page 1

Alliance Consulting BOND YIELDS & DURATION ANALYSIS. Bond Yields & Duration Analysis Page 1 BOND YIELDS & DURATION ANALYSIS Bond Yields & Duration Analysis Page 1 COMPUTING BOND YIELDS Sources of returns on bond investments The returns from investment in bonds come from the following: 1. Periodic

More information

Econ 330 Exam 1 Name ID Section Number

Econ 330 Exam 1 Name ID Section Number Econ 330 Exam 1 Name ID Section Number MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If during the past decade the average rate of monetary growth

More information

Click Here to Buy the Tutorial

Click Here to Buy the Tutorial FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following

More information

Chapter. Bond Prices and Yields. McGraw-Hill/Irwin. Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter. Bond Prices and Yields. McGraw-Hill/Irwin. Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Bond Prices and Yields McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Bond Prices and Yields Our goal in this chapter is to understand the relationship

More information

Chapter 6 Interest Rates and Bond Valuation

Chapter 6 Interest Rates and Bond Valuation Chapter 6 Interest Rates and Bond Valuation Solutions to Problems P6-1. P6-2. LG 1: Interest Rate Fundamentals: The Real Rate of Return Basic Real rate of return = 5.5% 2.0% = 3.5% LG 1: Real Rate of Interest

More information

Fixed Income Investment Strategies

Fixed Income Investment Strategies Fixed Income Investment Strategies Overall Bond Philosophy At EGI Financial, Inc. we believe the most important role fixed-income assets play in portfolio management is to reduce risk relative to an all

More information

Answers to Review Questions

Answers to Review Questions Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

More information

Exam 1 Morning Session

Exam 1 Morning Session 91. A high yield bond fund states that through active management, the fund s return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark

More information

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS 1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries

More information

Understanding duration and convexity of fixed income securities. Vinod Kothari

Understanding duration and convexity of fixed income securities. Vinod Kothari Understanding duration and convexity of fixed income securities Vinod Kothari Notation y : yield p: price of the bond T: total maturity of the bond t: any given time during T C t : D m : Cashflow from

More information

issue brief Duration Basics January 2007 Duration is a term used by fixed-income investors, California Debt and Investment Advisory Commission

issue brief Duration Basics January 2007 Duration is a term used by fixed-income investors, California Debt and Investment Advisory Commission issue brief California Debt and Investment Advisory Commission # 06-10 January 2007 Duration Basics Introduction Duration is a term used by fixed-income investors, financial advisors, and investment advisors.

More information

American Options and Callable Bonds

American Options and Callable Bonds American Options and Callable Bonds American Options Valuing an American Call on a Coupon Bond Valuing a Callable Bond Concepts and Buzzwords Interest Rate Sensitivity of a Callable Bond exercise policy

More information

Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 9-1 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as

More information

Bond Valuation. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Bond Valuation: An Overview

Bond Valuation. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Bond Valuation: An Overview Bond Valuation FINANCE 350 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University 1 Bond Valuation: An Overview Bond Markets What are they? How big? How important? Valuation

More information

Perspectives September

Perspectives September Perspectives September 2013 Quantitative Research Option Modeling for Leveraged Finance Part I Bjorn Flesaker Managing Director and Head of Quantitative Research Prudential Fixed Income Juan Suris Vice

More information

CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION CHAPTER 8 INTEREST RATES AND BOND VALUATION Answers to Concept Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial

More information

Understanding Fixed Income

Understanding Fixed Income Understanding Fixed Income 2014 AMP Capital Investors Limited ABN 59 001 777 591 AFSL 232497 Understanding Fixed Income About fixed income at AMP Capital Our global presence helps us deliver outstanding

More information

BOND - Security that obligates the issuer to make specified payments to the bondholder.

BOND - Security that obligates the issuer to make specified payments to the bondholder. Bond Valuation BOND - Security that obligates the issuer to make specified payments to the bondholder. COUPON - The interest payments paid to the bondholder. FACE VALUE - Payment at the maturity of the

More information

Impact of rising interest rates on preferred securities

Impact of rising interest rates on preferred securities Impact of rising interest rates on preferred securities This report looks at the risks preferred investors may face in a rising-interest-rate environment. We are currently in a period of historically low

More information

Bond Valuation. Capital Budgeting and Corporate Objectives

Bond Valuation. Capital Budgeting and Corporate Objectives Bond Valuation Capital Budgeting and Corporate Objectives Professor Ron Kaniel Simon School of Business University of Rochester 1 Bond Valuation An Overview Introduction to bonds and bond marketsĀ» What

More information

Brokered certificates of deposits

Brokered certificates of deposits Brokered certificates of deposits A guide to what you should know before you buy Are brokered CDs right for you? Brokered CDs are designed for investors who: Want access to a wide selection of issuers

More information

Chapter Review and Self-Test Problems. Answers to Chapter Review and Self-Test Problems

Chapter Review and Self-Test Problems. Answers to Chapter Review and Self-Test Problems 236 PART THREE Valuation of Future Cash Flows Chapter Review and Self-Test Problems 7.1 Bond Values A Microgates Industries bond has a 10 percent coupon rate and a $1,000 face value. Interest is paid semiannually,

More information

Individual Bonds or Bond Funds?

Individual Bonds or Bond Funds? Individual Bonds or Bond Funds? April 2014 When it comes to fixed income investing, advisors can choose between a variety of vehicles to implement bond portfolios. Many choose to construct ladders of individual

More information

1. General Obligation Bonds (G.O.s): Bonds backed by the full taxing power of the issuer.

1. General Obligation Bonds (G.O.s): Bonds backed by the full taxing power of the issuer. S&P INDICES Fixed Income February 2010 S&P Fixed Income Indices: Municipal Bond Investor Tool Kit Key Terms Alternative Minimum Tax (AMT): An extra tax that some taxpayers are required to pay in addition

More information

Best Credit Data Bond Analytics Calculation Methodology

Best Credit Data Bond Analytics Calculation Methodology Best Credit Data Bond Analytics Calculation Methodology Created by: Pierre Robert CEO and Co-Founder Best Credit Data, Inc. 50 Milk Street, 17 th Floor Boston, MA 02109 Contact Information: pierre@bestcreditanalysis.com

More information

Managing the Investment Portfolio

Managing the Investment Portfolio Managing the Investment Portfolio GSBC Executive Development Institute April 26, 2015 Portfolio Purpose & Objectives Tale of Two Balance Sheets o Components of Core Balance Sheet Originated loans Retail

More information

FIXED INCOME. Consistent Revenue A WIDER VIEW TM

FIXED INCOME. Consistent Revenue A WIDER VIEW TM FIXED INCOME Consistent Revenue A WIDER VIEW TM It s time for A WIDER VIEW. TM It s the view that says stocks, bonds, mutual funds, annuities, life insurance, every type of investment has to make a contribution

More information

ECO 4368 Instructor: Saltuk Ozerturk. Bonds and Their Valuation

ECO 4368 Instructor: Saltuk Ozerturk. Bonds and Their Valuation ECO 4368 Instructor: Saltuk Ozerturk Bonds and Their Valuation A bond is a long term contract under which a borrower (the issuer) agrees to make payments of interest and principal on speci c dates, to

More information

LOS 56.a: Explain steps in the bond valuation process.

LOS 56.a: Explain steps in the bond valuation process. The following is a review of the Analysis of Fixed Income Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Introduction

More information

STRIP BONDS AND STRIP BOND PACKAGES INFORMATION STATEMENT

STRIP BONDS AND STRIP BOND PACKAGES INFORMATION STATEMENT STRIP BONDS AND STRIP BOND PACKAGES INFORMATION STATEMENT We are required by provincial securities regulations to provide you with this Information Statement before you can trade in strip bonds or strip

More information

MONEY MARKET FUND GLOSSARY

MONEY MARKET FUND GLOSSARY MONEY MARKET FUND GLOSSARY 1-day SEC yield: The calculation is similar to the 7-day Yield, only covering a one day time frame. To calculate the 1-day yield, take the net interest income earned by the fund

More information

Interest Rate Options

Interest Rate Options Interest Rate Options A discussion of how investors can help control interest rate exposure and make the most of the interest rate market. The Chicago Board Options Exchange (CBOE) is the world s largest

More information

Chapter 5: Valuing Bonds

Chapter 5: Valuing Bonds FIN 302 Class Notes Chapter 5: Valuing Bonds What is a bond? A long-term debt instrument A contract where a borrower agrees to make interest and principal payments on specific dates Corporate Bond Quotations

More information

Interest Rates and Bond Valuation

Interest Rates and Bond Valuation Interest Rates and Bond Valuation Chapter 6 Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean

More information

CHAPTER 10. Bond Prices and Yields

CHAPTER 10. Bond Prices and Yields CHAPTER 10 Bond Prices and Yields Interest rates go up and bond prices go down. But which bonds go up the most and which go up the least? Interest rates go down and bond prices go up. But which bonds go

More information

CALCULATOR TUTORIAL. Because most students that use Understanding Healthcare Financial Management will be conducting time

CALCULATOR TUTORIAL. Because most students that use Understanding Healthcare Financial Management will be conducting time CALCULATOR TUTORIAL INTRODUCTION Because most students that use Understanding Healthcare Financial Management will be conducting time value analyses on spreadsheets, most of the text discussion focuses

More information

Investing in Bond Funds:

Investing in Bond Funds: : What s in YOUR bond fund? By: Bruce A. Hyde and Steven Saunders Summary Investors who rely primarily on duration in choosing a bond fund may inadvertently introduce extension risk to their bond portfolio.

More information

Yield Measures, Spot Rates & Forward Rates

Yield Measures, Spot Rates & Forward Rates Fixed Income Yield Measures, Spot Rates & Forward Rates Reading - 57 www.proschoolonline.com/ 1 Sources of Return Coupon interest payment: Periodic coupon interest is paid on the par value of the bond

More information

Bond Y is a 5% annual-pay bond with 15 years to maturity, priced at to yield 7%.

Bond Y is a 5% annual-pay bond with 15 years to maturity, priced at to yield 7%. The following is a review of the Analysis of Fixed Income Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Introduction

More information

Closed-End Funds. A closed-end fund is a type of investment company. whose shares are listed on a stock exchange

Closed-End Funds. A closed-end fund is a type of investment company. whose shares are listed on a stock exchange a guide to Closed-End Funds A closed-end fund is a type of investment company whose shares are listed on a stock exchange or are traded in the over-the-counter market. Contents What Is a Closed-End Fund?...2

More information

DURATION AND CONVEXITY

DURATION AND CONVEXITY CHAPTER 5 DURATION AND CONVEXITY KEY CONCEPTS Duration Modified duration Convexity DURATION Bonds, as discussed in previous chapters of this book, are subject to the following major risks: Risk of default

More information

Weekly Relative Value

Weekly Relative Value Back to Basics Identifying Value in Fixed Income Markets As managers of fixed income portfolios, one of our key responsibilities is to identify cheap sectors and securities for purchase while avoiding

More information

With interest rates at historically low levels, and the U.S. economy showing continued strength,

With interest rates at historically low levels, and the U.S. economy showing continued strength, Managing Interest Rate Risk in Your Bond Holdings THE RIGHT STRATEGY MAY HELP FIXED INCOME PORTFOLIOS DURING PERIODS OF RISING INTEREST RATES. With interest rates at historically low levels, and the U.S.

More information

Math of Finance. Texas Association of Counties January 2014

Math of Finance. Texas Association of Counties January 2014 Math of Finance Texas Association of Counties January 2014 Money Market Securities Sample Treasury Bill Quote*: N Bid Ask Ask Yld 126 4.86 4.85 5.00 *(Yields do not reflect current market conditions) Bank

More information

UNDERSTANDING INVESTMENT BASICS

UNDERSTANDING INVESTMENT BASICS UNDERSTANDING INVESTMENT BASICS Today s Presentation Purpose Objectives Topics O.R.C. 135.35 Due Diligence CDs Bonds Strategy INVESTMENT POLICY County Inactive Moneys - O.R.C. 135.35 Permissible Activities/Investments

More information

Investing in Bonds - An Introduction

Investing in Bonds - An Introduction Investing in Bonds - An Introduction By: Scott A. Bishop, CPA, CFP, and Director of Financial Planning What are bonds? Bonds, sometimes called debt instruments or fixed-income securities, are essentially

More information

U.S. Treasury Securities

U.S. Treasury Securities U.S. Treasury Securities U.S. Treasury Securities 4.6 Nonmarketable To help finance its operations, the U.S. government from time to time borrows money by selling investors a variety of debt securities

More information

Bonds and Yield to Maturity

Bonds and Yield to Maturity Bonds and Yield to Maturity Bonds A bond is a debt instrument requiring the issuer to repay to the lender/investor the amount borrowed (par or face value) plus interest over a specified period of time.

More information

ANALYSIS OF FIXED INCOME SECURITIES

ANALYSIS OF FIXED INCOME SECURITIES ANALYSIS OF FIXED INCOME SECURITIES Valuation of Fixed Income Securities Page 1 VALUATION Valuation is the process of determining the fair value of a financial asset. The fair value of an asset is its

More information

A guide to investing in hybrid securities

A guide to investing in hybrid securities A guide to investing in hybrid securities Before you make an investment decision, it is important to review your financial situation, investment objectives, risk tolerance, time horizon, diversification

More information

FNCE 301, Financial Management H Guy Williams, 2006

FNCE 301, Financial Management H Guy Williams, 2006 REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including

More information

High-yield bonds. Bonds that potentially reward investors for taking additional risk. High-yield bond basics

High-yield bonds. Bonds that potentially reward investors for taking additional risk. High-yield bond basics High-yield bonds Bonds that potentially reward investors for taking additional risk Types of high-yield bonds Types of high-yield bonds include: Cash-pay bonds. Known as plain vanilla bonds, these bonds

More information

Maturity targeted Bond Funds Lock in Anticipated Yield to Maturity

Maturity targeted Bond Funds Lock in Anticipated Yield to Maturity Winter 11 Maturity targeted Bond Funds Lock in Anticipated Yield to Maturity How fund dinvestors can benefit fitfrom the permanence and definition of portfolios of bonds, held to their maturity. Matthew

More information

A guide to investing in high-yield bonds

A guide to investing in high-yield bonds A guide to investing in high-yield bonds What you should know before you buy Are high-yield bonds suitable for you? High-yield bonds are designed for investors who: Can accept additional risks of investing

More information

Chapter 4 Bonds and Their Valuation ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 4 Bonds and Their Valuation ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 4 Bonds and Their Valuation ANSWERS TO END-OF-CHAPTER QUESTIONS 4-1 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as government

More information

Yield Curve September 2004

Yield Curve September 2004 Yield Curve Basics The yield curve, a graph that depicts the relationship between bond yields and maturities, is an important tool in fixed-income investing. Investors use the yield curve as a reference

More information

Index. 1. Financial Markets: Overview. 2. The Bond Market. 3. Risks Associated with Fixed Income Investments. 4. Bond Characteristics and Valuation

Index. 1. Financial Markets: Overview. 2. The Bond Market. 3. Risks Associated with Fixed Income Investments. 4. Bond Characteristics and Valuation Index 1. Financial Markets: Overview 2. The Bond Market 3. Risks Associated with Fixed Income Investments 4. Bond Characteristics and Valuation 5. Macro Environment Chapter 24 Bond Characteristics and

More information

FULL DISCLOUSURE. IncomeClub, Inc. ("IncomeClub") owns and operates a website at www.incomeclub.co.

FULL DISCLOUSURE. IncomeClub, Inc. (IncomeClub) owns and operates a website at www.incomeclub.co. FULL DISCLOUSURE June,1 2015 GENERAL DISCLOUSURES IncomeClub, Inc. ("IncomeClub") owns and operates a website at www.incomeclub.co. IncomeClub is registered investment advisor with the Securities and Exchange

More information

Chapter 6 Interest rates and Bond Valuation. 2012 Pearson Prentice Hall. All rights reserved. 4-1

Chapter 6 Interest rates and Bond Valuation. 2012 Pearson Prentice Hall. All rights reserved. 4-1 Chapter 6 Interest rates and Bond Valuation 2012 Pearson Prentice Hall. All rights reserved. 4-1 Interest Rates and Required Returns: Interest Rate Fundamentals The interest rate is usually applied to

More information

VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below

VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below 1. Determine the value of the following risk-free debt instrument, which promises to make the respective

More information

Federated New York Municipal Income Fund

Federated New York Municipal Income Fund Summary Prospectus October 31, 2015 Share Class A B Ticker NYIFX NYIBX Federated New York Municipal Income Fund A Portfolio of Federated Municipal Securities Income Trust Before you invest, you may want

More information

Bond Valuation. What is a bond?

Bond Valuation. What is a bond? Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities called bonds. A bond

More information

Finance Homework Julian Vu May 28, 2008

Finance Homework Julian Vu May 28, 2008 Finance Homework Julian Vu May 28, 2008 Assignment: p. 28-29 Problems 1-1 and 1-2 p. 145-147 Questions 4-2, 4-3, and 4-4, and Problems 4-1, 4-2, 4-3, and 4-13 P1-1 A Treasury Bond that matures in 10 years

More information

Investment Analysis (FIN 670) Fall Homework 3

Investment Analysis (FIN 670) Fall Homework 3 Investment Analysis (FIN 670) Fall 2009 Homework 3 Instructions: please read carefully You should show your work how to get the answer for each calculation question to get full credit You should make 2

More information

Managing cash in your portfolio

Managing cash in your portfolio Managing cash in your portfolio Vanguard research October 2012 Executive summary. Investors may maintain cash in their portfolios for a number of reasons, such as to cover daily living expenses and in

More information

Putnam Convertible Securities Fund

Putnam Convertible Securities Fund FUND SYMBOLS CLASS A CLASS B CLASS C CLASS M CLASS R CLASS Y PCONX PCNBX PRCCX PCNMX PCVRX PCGYX Putnam Convertible Securities Fund Summary prospectus 2 28 15 Putnam Convertible Securities Fund Before

More information

Introduction to Convertible Debentures

Introduction to Convertible Debentures Introduction to Convertible Debentures Intro to Convertible Debentures March, 2009 Convertible debentures are hybrid securities which offer advantages of both bonds and equities. Like ordinary bonds they

More information

Introduction to Futures Contracts

Introduction to Futures Contracts Introduction to Futures Contracts September 2010 PREPARED BY Eric Przybylinski Research Analyst Gregory J. Leonberger, FSA Director of Research Abstract Futures contracts are widely utilized throughout

More information

Tax-exempt municipal bonds

Tax-exempt municipal bonds Tax-exempt municipal bonds Fixed-income securities generally exempt from taxes Attractive benefits Tax-exempt municipal bonds are among the most popular types of investments available today. They offer

More information

A Guide to Investing in Floating-rate Securities

A Guide to Investing in Floating-rate Securities A Guide to Investing in Floating-rate Securities What to know before you buy Are floating rate bonds suitable for you? The features, risks and characteristics of floating rate bonds are different from

More information

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS

Module 1: Corporate Finance and the Role of Venture Capital Financing TABLE OF CONTENTS 1.0 ALTERNATIVE SOURCES OF FINANCE Module 1: Corporate Finance and the Role of Venture Capital Financing Alternative Sources of Finance TABLE OF CONTENTS 1.1 Short-Term Debt (Short-Term Loans, Line of

More information

Callable Bonds - Structure

Callable Bonds - Structure 1.1 Callable bonds A callable bond is a fixed rate bond where the issuer has the right but not the obligation to repay the face value of the security at a pre-agreed value prior to the final original maturity

More information

Answers to End-of-Chapter Questions

Answers to End-of-Chapter Questions Answers to End-of-Chapter Questions 1. The bond with a C rating should have a higher risk premium because it has a higher default risk, which reduces its demand and raises its interest rate relative to

More information

NATIONAL STOCK EXCHANGE OF INDIA LIMITED

NATIONAL STOCK EXCHANGE OF INDIA LIMITED NATIONAL STOCK EXCHANGE OF INDIA LIMITED Capital Market FAQ on Corporate Bond Date : September 29, 2011 1. What are securities? Securities are financial instruments that represent a creditor relationship

More information

Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)

Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.) Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing

More information

A guide to investing in high-yield bonds

A guide to investing in high-yield bonds A guide to investing in high-yield bonds What you should know before you buy Are high-yield bonds suitable for you? High-yield bonds are designed for investors who: Can accept additional risks of investing

More information

Residential Mortgage Finance. Early American Mortgages. Early Mortgage Lenders

Residential Mortgage Finance. Early American Mortgages. Early Mortgage Lenders Residential Mortgage Finance Early American Mortgages Mortgages before the Great Depression Generally were interest only (non- amortizing) loans Had Loan to Value Ratios under 50 % Were short term loans

More information

Active Fixed Income: A Primer

Active Fixed Income: A Primer Active Fixed Income: A Primer www.madisonadv.com Active Fixed Income: A Primer Most investors have a basic understanding of equity securities and may even spend a good deal of leisure time reading about

More information

Practice Questions for Midterm II

Practice Questions for Midterm II Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. -1. d. 0.5. By definition, the beta of the market portfolio is

More information

Chapter. Investing in Bonds. 13.1 Evaluating Bonds 13.2 Buying and Selling Bonds. 2010 South-Western, Cengage Learning

Chapter. Investing in Bonds. 13.1 Evaluating Bonds 13.2 Buying and Selling Bonds. 2010 South-Western, Cengage Learning Chapter 13 Investing in Bonds 13.1 Evaluating Bonds 13.2 Buying and Selling Bonds 2010 South-Western, Cengage Learning Standards Standard 4.0 Investigate opportunities available for saving and investing.

More information

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES 1. Expectations hypothesis. The yields on long-term bonds are geometric averages of present and expected future short rates. An upward sloping curve is

More information

Optimal Tax Management of Municipal Bonds

Optimal Tax Management of Municipal Bonds Optimal Tax Management of Municipal Bonds Andrew Kalotay President, Andrew Kalotay Associates, Inc. 61 Broadway Ste 1400 New York NY 10006 (212) 482 0900 andy@kalotay.com Page 1 Optimal Tax Management

More information

Internet Appendix for Taxes on Tax-Exempt Bonds

Internet Appendix for Taxes on Tax-Exempt Bonds Internet Appendix for Taxes on Tax-Exempt Bonds Andrew Ang Columbia University and NBER Vineer Bhansali PIMCO Yuhang Xing Rice University This Version: 11 November 2008 Columbia Business School, 3022 Broadway

More information

Chapter 10. Fixed Income Markets. Fixed-Income Securities

Chapter 10. Fixed Income Markets. Fixed-Income Securities Chapter 10 Fixed-Income Securities Bond: Tradable security that promises to make a pre-specified series of payments over time. Straight bond makes fixed coupon and principal payment. Bonds are traded mainly

More information

COMMUNICATING THE IMPACT OF THE NEXT PHASE OF COST BASIS LEGISLATION STARTING IN 2014

COMMUNICATING THE IMPACT OF THE NEXT PHASE OF COST BASIS LEGISLATION STARTING IN 2014 COMMUNICATING THE IMPACT OF THE NEXT PHASE OF COST BASIS LEGISLATION STARTING IN 2014 Financial Advisors and Tax Professionals are encouraged to collaborate, educate, and help clients plan for the next

More information

Understanding Leverage in Closed-End Funds

Understanding Leverage in Closed-End Funds Closed-End Funds Understanding Leverage in Closed-End Funds The concept of leverage seems simple: borrowing money at a low cost and using it to seek higher returns on an investment. Leverage as it applies

More information

6. Debt Valuation and the Cost of Capital

6. Debt Valuation and the Cost of Capital 6. Debt Valuation and the Cost of Capital Introduction Firms rarely finance capital projects by equity alone. They utilise long and short term funds from a variety of sources at a variety of costs. No

More information

FAQ. (Continued on page 2) An Investment Advisory Firm

FAQ. (Continued on page 2) An Investment Advisory Firm FAQ An Investment Advisory Firm What is QASH Flow Advantage? It is a time-tested model that includes three strategic components: A portfolio of carefully selected Exchange-Traded Funds (ETFs) for diversification

More information

Goals. Bonds: Fixed Income Securities. Two Parts. Bond Returns

Goals. Bonds: Fixed Income Securities. Two Parts. Bond Returns Goals Bonds: Fixed Income Securities History Features and structure Bond ratings Economics 71a: Spring 2007 Mayo chapter 12 Lecture notes 4.3 Bond Returns Two Parts Interest and capital gains Stock comparison:

More information

Fixed Annuities vs Bonds

Fixed Annuities vs Bonds Fixed Annuities vs Bonds A fixed annuity is a contract between an insurance company and one or more individuals, in which individuals make premium payments over the course of an accumulation period. The

More information