Fixed-Income
Securities
Fixed-Income Securities
Learning Goals
1. Explain the basic investment attributes of bonds
and their use as investments.
2. Describe the essential features of a bond, note
the role that bond ratings play in the market,
and distinguish among different types of call,
refunding, and sinking-fund provisions.
3. Explain how bonds are priced in the market and
why some bonds are more volatile than others.
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Fixed-Income Securities
Learning Goals (contd)
4. Identify the different types of bonds and the
kinds of investment objectives these securities
can fulfill.
5. Discuss the global nature of the bond market
and the difference between dollar-denominated
and nondollar-denominated foreign bonds.
6. Describe the basic features and characteristics
of convertible securities, and measure the value
of a convertible.
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Bond Ratings
Bond ratings are letter grades that designate investment
quality
Private bond rating agencies assign ratings based upon
financial analysis of the bond issuer
Investment grade ratings are received by financially
strong companies
Junk bond ratings are received by companies making
payments, but default risk is high
Split ratings occur when a bond issue is given different
ratings by major rating agencies
Higher rated bonds have less default risk and pay lower
interest rates
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Treasury Bonds
Considered risk freeno risk of default
Interest is exempt from state and local taxes
Sold in $1,000 denominations
Types of Treasury Bonds
Treasury notes: maturities of 2, 3, 5, 7, and 10 years
Treasury bonds: mature in 30 years
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Agency Bonds
Issued by U.S. government agencies
Federal Home Loan Bank
Federal National Mortgage Association
Small Business Administration
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Municipal Bonds
Issued by states, counties, cities and any
other political subdivision
Issued to fund public projects
Two basic types
General obligation bonds are paid from general
fund of the issuer
Revenue bonds are paid from revenues from the
project being financed
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Municipal Bonds
Interest is tax-exempt for Federal taxes
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Corporate Bonds
Issued by corporations from four major
segments
Industrials
Public utilities
Rail and transportation bonds
Financial issues
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Zero-Coupon Bonds
Do not pay interest
Sold at deep discount from par value
Value increases over time
Subject to tremendous price volatility as interest
rates fluctuate
Interest must be reported as it is accrued for tax
purposes, even though no interest is actually
received.
Treasury strips are zero-coupon bonds created
from U.S. Treasury securities.
Copyright 2014 Pearson Education, Inc. All rights reserved.
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Mortgage-Backed Securities
Bond backed by pool of residential mortgages
Principal and interest are paid monthly
Governmental agencies are major issuers:
Government National Mortgage Association (GNMA)
Federal Home Loan Mortgage Corporation (FHLMC)
Federal National Mortgage Association (FNMA)
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Asset-Backed Securities
Issued by corporations and backed by pools
of loans
Auto loans
Credit card loans
Home equity loans
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Global Bonds
Potentially higher returns than U.S. bonds
Offer broader diversification opportunities
Interest rate trends in other countries may
not follow U.S. rates
Currency exchange rate fluctuations can
impact returns in U.S. dollars
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Dollar-Denominated Bonds
Bonds issued by foreign governments or
corporations and denominated in dollars
Based on U.S. dollars
Yankee bonds are registered with the SEC
and issued and traded in U.S.
Eurodollar bonds are not registered with
the SEC and are issued and traded outside
of the U.S.
No currency exchange rate risk since bonds
are in U.S. dollars
Copyright 2014 Pearson Education, Inc. All rights reserved.
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Foreign-Pay Bonds
Bonds issued by foreign governments
or corporations
Based on currency other than U.S. dollars
Not registered with the SEC and issued and
traded outside of the U.S.
Subject to currency exchange rate risk
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Convertible Securities
Fixed-income security that allows holder to convert
the security into a specified number of shares of
the issuing companys common stock
Two major types of convertible securities:
Convertible bonds
Convertible preferred stock
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Sources of Value
Value of convertibles is based in both the stock and
the bond dimensions of the security
Convertibles trade much like common stock as the
market price of the stock starts getting close to (or
exceeds) the stated conversion price
Convertibles trade much like a bond when the
market price of the stock is well below the
conversion price
Bond price sets a price floor in case the stock price goes
into a freefall
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Chapter 10 Review
Learning Goals
1. Explain the basic investment attributes of
bonds and their use as investments.
2. Describe the essential features of a bond, note
the role that bond ratings play in the market,
and distinguish among different types of call,
refunding, and sinking-fund provisions.
3. Explain how bonds are priced in the market and
why some bonds are more volatile than others.
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Chapter 10
Additional Chapter
Art
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