Comprehensive Overview of Bonds

Sep 1, 2024

Lecture Notes: Understanding Bonds

Introduction

  • Bonds are crucial financial vehicles.
    • Serve as IOUs for funding without transferring ownership.
    • Essential for towns, governments, companies, etc.
  • Bonds differ from traditional loans by being a form of security.

Key Characteristics of Bonds

  • Security: Tradable assets in the form of securities.
  • Stability: Referred to as fixed income instruments.
  • Interest Rates: Bond prices inversely correlate with interest rates.
  • Maturity Date: Date when the bond's full value is repaid.

Why Bonds Over Loans?

  • Easier to crowdsource large amounts compared to bank loans.
  • Allows individual investors to lend to massive entities.

How Bonds Work

  • Tradable publicly or privately.
  • Include terms, interest payments, and maturity date.
  • Coupon: Interest payments made over time.
  • Coupon Rate: The interest rate of the bond.
  • Par Value: Usually $100 or $1000.

Factors Influencing Bond Value

  • Credit Quality: Issuer's financial stability.
  • Time to Maturity: Longer times often mean higher interest rates.
  • Coupon Rate: Compared to market averages.

Types of Bonds

  1. Corporate Bonds: Issued by companies.
  2. Municipal Bonds: Issued by states or cities.
  3. Government Bonds: Issued by national authorities.
  4. Agency Bonds: From government-affiliated organizations.

Special Bond Structures

  1. Zero Coupon Bonds: Sold at a discount, no interest payments.
  2. Convertible Bonds: Can be converted into stock.
  3. Callable Bonds: Can be bought back by the issuer.
  4. Putable Bonds: Can be sold back to the issuer by the holder.

Investment Considerations

  • Bonds can either be stable or risky investments.
  • Investment Grade Bonds: Stable, low risk (e.g., US government bonds).
  • High-Yield Bonds/Junk Bonds: Higher risk, potential for higher returns.

Pricing of Bonds

  • Bond prices fluctuate like any security.
  • Market Factors: Supply and demand influence pricing.

Conclusion

  • Bonds are essential for understanding modern investing.
  • They provide both opportunities and risks within investment portfolios.