Bond- Tổng quan về trái phiếu

Bond- Tổng quan về trái phiếu

TABLE OF CONTENT

A INTRODUCTION 2

I OVERVIEW OF BOND 3

1 Definition 3

2 Features of bond 3

2.1 Par value/ Face Value/ Principal 3

2.2 Coupon 3

2.3 Maturity date 3

2.4 Bond pricing 4

2.5 Credit rating 5

(Source: Fundamentals of Investments, Charles J Corrado, Chapter 11, page 33) 8

2.6 Callability 8

2.7 Putability 8

3 How are bonds different from stocks? 8

II INSTITUTION ISSUING BONDS 9

1 Government bonds 9

2 Municipal bonds 10

3 Corporate bonds 10

3.1 Definition 10

3.2 Advantages of bond financing over a bank loan 10

3.2.1 Fixed Interest Rate 10

3.2.2 Long-term Loan, Fully Amortized 11

3.2.3 Open-ended Mortgage 11

3.2.4 Liberal Prepayment Provisions 11

3.3 Type of corporate bond 12

3.3.1 Secured bond 12

3.3.3 Convertible bond 12

3.3.4 Junk bond 13

3.3.5 Zero coupon bond 13

3.4 Requirements 13

III RISK OF INVESTING IN BONDS 14

1 Interest Rate Risk 14

2 Inflation Risk 14

3 Default Risk 15

4 Rating Downgrades 15

5 Liquidity Risk 15

IV WHY BUYING BOND? 16

1 Income predictability 16

2 Safety 16

3 Choice 16

B CONCLUSION: 16

C REFERENCES 17

A Introduction

Nowadays, in whatever economic types, the capital always plays an extremely

important role It is not only important in day-by-day needs but also in many aspects of the real life

With business organizations, they need capital to buy or lease real estate for placing the factory, the office, the inventory goods…; to purchase materials for producing

merchandise; to distribute the merchandise from producers to consumers, to pay for employees, etc So how they can obtain the needed capital for their business? There are many ways to raise capital such as: mortgage assets, borrowing from the financial institutions or banks, issuing stocks or bonds, etc

With government, they need capital to do the government projects, to do profit or non-profit activities, etc So how they can do it? Increasing any types of taxes? Increasing the price of products which are under the management of the government? Borrowing from other countries? Selling the real materials abroad with the low price? Issuing stocks or bonds? etc

With many people who have free-cash and want to use it usefully without doing

business, how they can do with their money? Lending? Saving in banks? Buying stocks

or bonds? etc

They have many ways to choose They can find the best way which is suitable for their own situation However, there are many organizations choose issuing bonds, and many people choose buying bonds instead of stocks Why they choose this way? How they can do it? What are the bonds?

Today, we will introduce about BONDS, a way to raise capital for business

I Overview of bond

1 Definition

Bond is a debt instrument issued for a period of time with the purpose of raising capital

by borrowing The issuer is the borrower (debtor), the holder is the lender (creditor) Institutions that sell bond are governments, cities, corporations

Coupon interest, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains) are the three factors affecting the yield of bond

2 Features of bond

2.1 Par value/ Face Value/ Principal

The face value (also known as the par value or principal) is the amount of money

printed on the bond, on which the issuer pays interest and the holder will get back when bond matures

2.2 Coupon

The interest rate printed on bond expressed as a percentage of the par It can be paid monthly, quarterly, semi-annually or annually The risk and the maturity date will affect the coupon The more risk the bond is and the longer the maturity date the bond has, the higher interest rate is

2.3 Maturity date

The date when bond comes due and the issuer has to repay principal to the holders

Municipal bonds issued in 2005 in Ho Chi Minh city

2.4 Bond pricing

The real price that investor pay for the bond It can be higher, equal or lower than the nominal value However, whatever the buying price is, the coupon is still determined by nominal value and the issuer still pay the principal when bond matures

The buying price of bond is opposite with interest rate on the secondary market When interest rate increases, the bond price will decrease and when interest rate decreases, bond price will go up

Example: a company issues a bond with par value $1000, coupon 8% After a period of

time:

Case 1: Interest rate on secondary market is 10% New bond (a bond with

similar characteristics such as credit quality and maturity) coupon is 10%

Instead of holding old bond, investors will use their money to buy new bond

Therefore, they will sell old bond at price lower than its nominal value to make it

competitive The 8% bond’s interest payments would have a current yield of 10 % only

if that bond could be bought for $800 Now, the price falls from $1000 to $800 (-20%)

The bond is said to be selling at a discount

Case 2: Interest rate on secondary market is 6% New bond coupon is 6%

Instead of buying new bond, investors will keep old bond Therefore, the price of old bond in the secondary market will increase The 8% bond’s interest payments would have a current yield of 6% only if that bond could be bought for $1333 Now the price

goes up from $1000 to $1333 (+30%) The bond is said to be selling at a premium.

2.5 Credit rating

A credit rating evaluates the credit worthiness of a corporation, or a country Therefore,

a credit rating let a lender or investor know whether the issuer can pay back a loan If the issuers have a poor credit rating, they also have a high risk of default or bankrupt, that leads to high interest rates, or the refusal of a loan by the creditor The evaluation is necessary for the investors will be protected

When a corporation sells a new bond issue to investors, it usually subscribes to several bond rating agencies for a credit evaluation of the bond issue Each contracted rating

agency then provides a credit rating - an assessment of the credit quality of the bond

issue based on the issuer's financial condition Rating agencies will normally provide a credit rating only if it is requested by an issuer and will charge a fee for this service As part of the contractual arrangement between the bond issuer and the rating agency, the issuer agrees to allow a continuing review of its credit rating even if the rating

deteriorates Without a credit rating a new bond issue would be very difficult to sell to the public, which is why almost all bond issues originally sold to the general public have a credit rating assigned at the time of issuance Also, most public bond issues have ratings assigned by several rating agencies

Some rating agencies in the United States are Duff and Phelps, Inc (D&P), Fitch

Investors Service (Fitch), McCarthy, Crisanti and Maffei (MCM), Moody's Investors Service (Moody's), and Standard and Poor's Corporation (S&P) Moody's and Standard and Poor's is considered the two best rating companies These companies publish

regularly updated credit ratings for thousands of domestic and international bond issues

Rating agency

Moody’s Duff &

Phelps

Standard

& Poor’s

Credit Rating Description

Investment Grade Bond Ratings

Aaa

Aa1

1 2

AAA AA+

Highest credit rating, maximum safety

Aa3

A1

3 4 5

AA AA-A+

High credit quality, investment-grade bonds

A2

A3

Baa1

6 7 8

A A-BBB+

Upper-medium quality, investment-grade bonds

Baa2

Baa3

9 10

BBB

BBB-Lower-medium quality, investment-grade bonds

Speculative Grade Bond Ratings

Ba1

Ba2

Ba3

11 12 13

BB+

BB

BB-Low credit quality, speculative-grade bonds

B1

B2

B3

14 15 16

B+

B

B-Very low credit quality, speculative-grade bonds

Extremely Speculative Grade Bond Ratings.

CCC

CCC-Extremely low credit standing, high-risk bonds

C

CC C D

Extremely speculative

Bonds in default

(Source: Fundamentals of Investments, Charles J Corrado, Chapter 11,

page 33)

2.6 Callability

The characteristic of a bond gives the issuer the right to take back or redeem bonds before they mature under certain conditions The sooner the bond is called, the higher is the price which issuer has to pay to the bond holders The issuers use this right to make sure that they don’t pay the higher interest on the debt in case the interest on the market

is lower than interest of the bond When they redeem all the bonds, they will reissue them at a lower interest rate than that of the previous bonds

2.7 Putability

The characteristic of bond gives the holder the right to sell the bonds to the issuer before they mature under certain condition When the interest rate in the market

increase (causing bond value to decrease), the bond holder can sell bonds back to the issuer to recover the loss

3 How are bonds different from stocks?

Bonds are considered debt investments, the bond holder become the creditor of the company On the contrary, a stock is considered an equity investment because the investor (stockholder) becomes a part owner of the corporation

The bond holders don’t have the right to participate in corporation’s operations because they are just creditors Whereas the stockholder may have the right in voting in the company

The issuer of bond is government, corporation or city However, only corporations issue stock

Bond holders earn fixed income from interest of the bonds On the other hand,

stockholder receive dividend - a proportion on the corporation’s profits and it’s not fixed

Bonds have maturity date but stocks don’t

Because bondholders are creditors rather than part owners, if a corporation goes

bankrupt, bondholders have a higher claim on assets than stockholders This makes bond investor safer

II Institution issuing bonds

1 Government bonds

A government bond is a bond issued by a national government denominated in the country's own currency

Government bonds are considered no risk, because the government can raise taxes to buy back the bond at maturity

However, there still exist other risks

First, it is currency risk for foreign investors For example Foreign investors buying US Treasury bond received lower returns in 2004 because of the decline in value of US dollar comparing with other currencies

Second, there is inflation risk, which is the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected

2 Municipal bonds

Municipal bonds are debt securities that states, cities, counties, and other

governmental issue to raise money for public purposes—such as building schools, highways, hospitals, and other special projects

A feature of many municipal securities is that the interest you receive is free tax from federal income tax The interest may also be free tax from state and local if you live in the state where the bond is issued

3 Corporate bonds

3.1 Definition

A corporate bond is a bond issued by a company That is a bond that a corporation issues to raise money in order to expand its business

Unlike government bond, corporate bond is exposed to default risk Different corporate bonds have different levels of default risk, depending on the issuer company’s

characteristics The larger the default risk, the higher the interest the issuers have to pay

3.2 Advantages of bond financing over a bank loan

3.2.1 Fixed Interest Rate

Most banks offer loans with adjustable interest rate in case it rise, so your organization have to pay higher interest when having an increasing in interest rate

With bond financing, your interest rate is fixed for the term of the loan Budgeting is simplified by knowing interest and principal payments are fixed for the entire term of the loan Your concern about rising interest rates is eliminated

3.2.2 Long-term Loan, Fully Amortized

Many bank loans are only in three to five years, with a large payment due at the end of the term This means you must refinance your loan at a later date If the financial

position of your organization has changed at the time, or if interest rates have risen, you might be unable to refinance Why do you expose your organization to this risk?

Most bond issues are fully amortized over a five-year to twenty-year period, depending

on your needs Level debt service aids in budgeting, and ensures that the loan can eventually be retired without the hassle of refinancing every three to five years

3.2.3 Open-ended Mortgage

If you need more money, most banks will require you to refinance your old loan This means that you have to pay a higher interest rates, and certainly new loan fees for refinancing your existing loan

Meanwhile, with bond, the mortgage documents allow your organization to borrow additional sums at later dates without disturbing the original loan or adding financing costs to previous loans This is very important for your organization if you need more money in the future to expand production or doing business

3.2.4 Liberal Prepayment Provisions

Many banks have prepayment penalties written into their commercial loan contracts This can make it unattractive to use excess cash to pay down your loan

Under the bond program, prepayment of any amount of principal with unborrowed funds is allowed without penalty You can lower the effective interest rate on your loan

by specifying prepayment of the longer-term bonds, which pay higher interest rates than the shorter-term bonds Then, you may also lower your normal loan payments

accordingly They do have some limitations on prepayment of bonds with funds

borrowed specifically for refinancing during the first three years of the loan This gives some assurance to the bondholders that they will have their investment for a reasonable duration

3.3 Type of corporate bond

3.3.1 Secured bond

A secured bond is a type of bond that is guaranteed by the specific assets as collateral of the company, such as a mortgage, revenue, equipment which would be paid to the bondholders in case the company goes bankrupt The most common form of secured bonds are mortgage bonds ( guaranteed by real estate or physical) If an issuer gets default , secured bondholders are paid off first, then unsecured bondholders

3.3.2 Unsecured bond (debenture)

An unsecured bond is a type which is not guaranteed by equipment , revenue, mortgage Instead, the issuers promise that they will repay all Unsecured bonds carry more risk than secured bond Therefore, it offers higher interest rates than do secured bonds

3.3.3 Convertible bond

Convertible bond is a kind of bond which is able to convert to shares The issuers allow the bond holders the right to change bond into shares The holders have the right not to convert into shares if the company ‘s business is not good Generally, this type of bond