Thị trường tài chính và các định chế tài chính_ Chapter 07

Treasury and Federal Agency Bonds cont’d  The Salomon Brothers scandal  In a 1990 bond auction, Salomon Brothers purchased 65 percent of the bonds issued exceeding the 35 percent maxim

Chapter 7

Bond Markets

 Institutional use of bond markets

 Globalization of bond markets

Background on Bonds

 Bonds represents long-term debt securities that are

issued by government agencies or corporations

 Interest payments occur annually or semiannually

 Par value is repaid at maturity

 Most bonds have maturities between 10 and 30 years

 Bearer bonds require the owner to clip coupons

attached to the bonds

 Registered bonds require the issuer to maintain records

of who owns the bond and automatically send coupon

payments to the owners

Background on Bonds (cont’d)

 Does not include transaction costs associated with issuing the bond

 Earned by an investor who invests in a bond when it is issued and holds it until maturity

 The holding period return is used by investors who do not hold a bond to maturity

Treasury and Federal Agency

Bonds

 The U.S Treasury issues Treasury notes

or bonds to finance federal government

expenditures

 Note maturities are usually less than 10 years

October 2001

Treasury and Federal Agency

Bonds (cont’d)

 Normally held in the middle of each quarter

 Financial institutions submit bids for their own

accounts or for clients

 Bids can be competitive or noncompetitive

 Competitive bids specify a price the bidder is willing to pay and a dollar amount of securities to be purchased

 Noncompetitive bids specify only a dollar amount of securities to be purchased

Treasury and Federal Agency

Bonds (cont’d)

 The Salomon Brothers scandal

 In a 1990 bond auction, Salomon Brothers purchased 65 percent of the bonds issued (exceeding the 35 percent maximum)

 Salomon resold the bonds at higher prices to other institutions

 In August of 1991, the Treasury Department temporarily barred Salomon Brothers from bidding on Treasury securities

 In May 1992 Salomon paid fines of $190 million to the SEC and Justice Department

 Salomon created a reserve fund of $100 million to cover claims from civil lawsuits

Treasury and Federal Agency

Bonds (cont’d)

 Bond dealers serve as intermediaries in the

secondary market and also take positions in the

bonds

 30 primary dealers dominate the trading

 Profit from the bid-ask spread

 Conduct trading with the Fed during open market operations

 Typical daily volume is about $200 billion

 Online trading

 TreasuryDirect program (http://www.treasurydirect.gov)

Treasury and Federal Agency

Bonds (cont’d)

 Treasury bond quotations

 Published in financial newspapers

 The Wall Street Journal

 Barron’s

 Investor’s Business Daily

 Bond quotations are organized according to their maturity, with the shortest maturity listed first

 Bid and ask prices are quoted per hundreds of dollars of par

value

 Online quotations at

 http://www.investinginbonds.com

 http://www.federalreserve.gov/releases/H15/

Treasury and Federal Agency

Bonds (cont’d)

 Stripped Treasury bonds

 One security represents the principal payment and a second security represents the interest payments

 Investors who desire a lump sum payment can choose the

PO part

 Investors desiring periodic cash flows can select the IO part

 Degrees of interest rate sensitivity vary

 Several securities firms create their own versions of

stripped securities

 Merrill Lynch’s TIGRs

 The Treasury created the STRIPS program in 1985

Treasury and Federal Agency

Bonds (cont’d)

 In 1996, the Treasury started issuing inflation-indexed bonds that provide a return tied to the inflation rate

 The coupon rate is lower than the rate on regular

Treasuries, but the principal value increases by the amount of the inflation rate every six months

 Inflation-indexed bonds are popular in high-inflation countries such as Brazil

Computing the Interest Payment

of an Inflation-Indexed Bond

A 10-year bond has a par value of $1,000 and a coupon rate of 5 percent During the first six

months after the bond was issued, the inflation

rate was 1.3 percent By how much does the

principal of the bond increase? What is the

coupon payment after six months

?

65 50

$

$1,013 5%

Payment Coupon

013 ,

1

$ 1.013

Treasury and Federal Agency

Bonds (cont’d)

 Savings bonds

 Series EE bonds provide a market-based interest rate

 Series I bonds provide a rate of interest tied to inflation

 Interest on savings bonds is not subject to state and local taxes

 Federal agency bonds

insured by the FHA and the VA

mortgages

Municipal Bonds

 Municipal bonds can be classified as either general

obligation bonds or revenue bonds

 General obligation bonds are supported by he municipal

government’s ability to tax

 Revenue bonds are supported by the revenues of the project for which the bonds were issued

 Municipal bonds typically pay interest semiannually, with minimum denominations of $5,000

 Municipal bonds have a secondary market

 Most municipal bonds contain a call provision

Municipal Bonds (cont’d)

 Credit risk

 Less than 5 percent of all municipal bonds

issued since 1940 have defaulted

Investor Service assign ratings to municipal bonds

default

 Results in a higher cost for the investor

Municipal Bonds (cont’d)

 Variable-rate municipal bonds

benchmark interest rate

 Some variable-rate munis are convertible to a fixed rate under specified conditions

Municipal Bonds (cont’d)

 Interest income is normally exempt from federal taxes

 Interest income earned on bonds that are issued by a municipality within a particular state is exempt from state income taxes

 Interest income earned on bonds issued by a

municipality within a city in which the local

government imposes taxes is normally exempt from the local taxes

Municipal Bonds (cont’d)

 Trading and quotations

 Investors can buy or sell munis by contacting brokerage firms

 http://www.tradingedge.com

 Online quotations are available at

http://www.munidirect.com and

http://www.investinginbonds.com

Municipal Bonds (cont’d)

 Yields offered on municipal bonds

 Differs from the yield on a Treasury bond with the same maturity because:

 Of a risk premium to compensate for default risk

 Of a liquidity premium to compensate for less liquidity

 The federal tax exemption of municipal bonds

Municipal Bonds (cont’d)

 Yield curve on municipal bonds

 Typically lower than the Treasury yield curve because of the tax differential

 The municipal yield curve has a similar shape

as the Treasury yield curve because:

 It is influenced similarly by interest rate expectations

 Investors require a premium for longer-term securities with lower liquidity in both markets

Corporate Bonds

periods

 Larger bonds offerings are achieved through public offerings

registered with the SEC

 Secondary market activity varies

 Financial and nonfinancial institutions as well as individuals are

common purchasers

 Interest paid by corporations is tax-deductible, which reduces the corporate cost of financing with bonds

Corporate Bonds (cont’d)

 Interest income earned on corporate represents

 Less than 1 percent in the late 1990s

Corporate Bonds (cont’d)

 Corporate bond yields and risk (cont’d)

 Investor assessment of risk

 Investors may only consider purchasing corporate bonds after assessing the issuing firm’s financial condition and ability to cover its debt payments

 Investors may rely heavily on financial statements created by the issuing firm, which may be misleading

 Bonds with higher ratings have lower yields

 Corporations seek investment-grade ratings, since commercial banks will only invest in bonds with that status

 Rating agencies will not necessarily detect any misleading information contained in financial statements

Corporate Bonds (cont’d)

 Private placement of corporate bonds

funds purchase privately-placed bonds

 Bonds can be placed with the help of a

securities firm

 Bonds do not have to be registered with the SEC

Corporate Bonds (cont’d)

 Characteristics of corporate bonds

 The bond indenture specifies the rights and obligations of the

issuer and the bondholder

 A trustee represents the bondholders in all matters concerning

the bond issue

 Often limit the amount of dividends and corporate officers’ salaries the firm can pay

Corporate Bonds (cont’d)

 Characteristics of corporate bonds (cont’d)

 Call provisions:

 Require the firm to pay a price above par value when it calls its bonds

 The difference between the call price and par value is

the call premium

 Are used to:

 Issue bonds with a lower interest rate

 Retire bonds as required by a sinking-fund provision

 Are a disadvantage to bondholders

Corporate Bonds (cont’d)

 Bond collateral

 Typically, collateral is a mortgage on real property

 A first mortgage bond has first claim on the specified

assets

 Unsecured bonds are debentures

 Subordinated debentures have claims against the

firm’s assets that are junior to the claims of mortgage bonds and regular debentures

Corporate Bonds (cont’d)

 Are issued at a deep discount from par value

 Require annual tax payments although the interest will not be received until maturity

 Have the advantage to the issuer of requiring low or no cash outflow

 Allow investors to benefit from rising market interest rates over time

 Allow issuers of bonds to benefit from declining rates over time

 Convertibility

 Convertible bonds allow investors to exchange the bond for a stated

number of shares of common stock

 Investors are willing to accept a lower rate of interest on convertible

bonds

Corporate Bonds (cont’d)

 Trading corporate bonds

bond dealers

 A market order transaction occurs at the prevailing market price

 A limit order transaction will occur only if the price reaches a

specified limit

 Bonds listed on the NYSE are traded through the automated

Bond System (ABS)

 Online trading is possible at:

 http://www.schwab.com

 http://www.etrade.com

Corporate Bonds (cont’d)

 Corporate bond quotations

NYSE with a market value of more than $2

trillion

 Corporate bond prices are reported in eighths

the volume of trading and the yield to maturity

Corporate Bonds (cont’d)

 Junk bonds

 About two-thirds of junk bonds are used to finance takeovers

 Size of the junk bond market

 Currently about 3,700 junk bond offerings exist with a market value

of $80 billion

 Participation in the junk bond market

 70 large issuers of junk bonds each have more than $1 billion in debt outstanding

 Primary investors in junk bonds are mutual funds, life insurance companies, and pension funds

 The junk bond secondary market consists of 20 bond traders

Corporate Bonds (cont’d)

 Risk premium of junk bonds

 The typical premium is between 3 and 7 percent above Treasury bonds with the same maturity

 Performance of junk bonds

 In the early 1990s, the popularity of junk bonds declined because of

 Insider trading allegations

 The financial problems of a few major issuers of junk bonds

 The financial problems in the thrift industry

 In the late-1990s, junk bonds performed well with few defaults

Corporate Bonds (cont’d)

 Junk bonds (cont’d)

 Contagion effects in the junk bond market

 Specific adverse information may discourage investors from investment in junk bonds

 Ivan Boesky admitting to insider trading violations

 Drexel Burnham Lambert’s bankruptcy filing

Corporate Bonds (cont’d)

 How corporate bonds facilitate

restructuring

 An LBO is typically financed with senior debt and subordinated debt

 LBO activity increased dramatically in the later 1980s

 Many firms with excessive financial leverage resulting from LBOs reissued stock in the 1990s

Corporate Bonds (cont’d)

 How corporate bonds facilitate restructuring

(cont’d)

 Using bonds to revise the capital structure

 Debt is perceived to be a cheaper source of capital than equity as long as the corporation can meet its debt payments

for a debt-for-equity swap

 Corporations with an excessive amount of debt can conduct

an equity-for-debt swap

Institutional Use of Bond Markets

 All financial institutions participate in bond

markets

 On any given day, commercial banks, bond mutual funds, insurance companies, and pension funds are dominant participants

 A financial institution’s investment decisions will often simultaneously affect bond market and

other financial market activity

Globalization of Bond Markets

integrated as a result of frequent cross-border investments in bonds

 Low-quality bonds issued globally by

governments and large corporations are global junk bonds

primarily attributed to bond offerings by country governments (sovereign bonds)

Globalization of Bond Markets

(cont’d)

placed in the Eurobond market

available in the Eurobond market

issues