Bond (nance)

In nance, a bond s an nstrument of ndebtedness of the bond ssuer to the

hoders. It s a debt securty, under whch the ssuer owes the hoders a debt
and, dependng on the terms of the bond, s obged to pay them nterest (the
coupon) and/or to repay the prncpa at a ater date, termed the maturty
date.|1| Interest s usuay payabe at xed ntervas (semannua, annua,
sometmes monthy). Very often the bond s negotabe, .e. the ownershp of
the nstrument can be transferred n the secondary market. Ths means that
once the transfer agents at the bank medaon stamp the bond, t s hghy
qud on the second market. |2|
Thus a bond s a form of oan or IOU (sounded "I owe you"): the hoder of the
bond s the ender (credtor), the ssuer of the bond s the borrower (debtor),
and the coupon s the nterest. Bonds provde the borrower wth externa
funds to nance ong-term nvestments, or, n the case of government bonds,
to nance current expendture. Certcates of depost (CDs) or short term
commerca paper are consdered to be money market nstruments and not
bonds: the man dherence s n the ength of the term of the nstrument.
Bonds and stocks are both securtes, but the ma|or dherence between the
two s that (capta) stockhoders have an equty stake n the company (.e.
they are nvestors), whereas bondhoders have a credtor stake n the
company (.e. they are enders). Beng a credtor, bondhoders have absoute
prorty and w be repad before stockhoders (who are owners) n the event
of bankruptcy.|3| Another dherence s that bonds usuay have a dened
term, or maturty, after whch the bond s redeemed, whereas stocks are
typcay outstandng ndentey. An excepton s an rredeemabe bond, such
as Consos, whch s a perpetuty, .e. a bond wth no maturty.
Issuance|edt|
Bonds are ssued by pubc authortes, credt nsttutons, companes and
supranatona nsttutons n the prmary markets. The most common process
for ssung bonds s through underwrtng. When a bond ssue s underwrtten,
one or more securtes rms or banks, formng a syndcate, buy the entre
ssue of bonds from the ssuer and re-se them to nvestors. The securty rm
takes the rsk of beng unabe to se on the ssue to end nvestors. Prmary
ssuance s arranged by bookrunners who arrange the bond ssue, have drect
contact wth nvestors and act as advsers to the bond ssuer n terms of
tmng and prce of the bond ssue. The bookrunner s sted rst among a
underwrters partcpatng n the ssuance n the tombstone ads commony
used to announce bonds to the pubc. The bookrunners' wngness to
underwrte must be dscussed pror to any decson on the terms of the bond
ssue as there may be mted demand for the bonds.
In contrast, government bonds are usuay ssued n an aucton. In some
cases both members of the pubc and banks may bd for bonds. In other
cases ony market makers may bd for bonds. The overa rate of return on
the bond depends on both the terms of the bond and the prce pad.|4| The
terms of the bond, such as the coupon, are xed n advance and the prce s
determned by the market.
In the case of an underwrtten bond, the underwrters w charge a fee for
underwrtng. An aternatve process for bond ssuance, whch s commony
used for smaer ssues and avods ths cost, s the prvate pacement bond.
Bonds sod drecty to buyers and may not be tradeabe n the bond market.
|5|
Hstorcay an aternatve practce of ssuance was for the borrowng
government authorty to ssue bonds over a perod of tme, usuay at a xed
prce, wth voumes sod on a partcuar day dependent on market condtons.
Ths was caed a tap ssue or bond tap.|6|
Features|edt|
Prncpa|edt|
Nomna, prncpa, par or face amount s the amount on whch the ssuer
pays nterest, and whch, most commony, has to be repad at the end of the
term. Some structured bonds can have a redempton amount whch s
dherent from the face amount and can be nked to performance of partcuar
assets.
Maturty|edt|
The ssuer has to repay the nomna amount on the maturty date. As ong as
a due payments have been made, the ssuer has no further obgatons to
the bond hoders after the maturty date. The ength of tme unt the
maturty date s often referred to as the term or tenor or maturty of a bond.
The maturty can be any ength of tme, athough debt securtes wth a term
of ess than one year are generay desgnated money market nstruments
rather than bonds. Most bonds have a term of up to 30 years. Some bonds
have been ssued wth terms of 50 years or more, and hstorcay there have
been some ssues wth no maturty date (rredeemabes). In the market for
Unted States Treasury securtes, there are three categores of bond
maturtes:
short term (bs): maturtes between one to ve year; (nstruments wth
maturtes ess than one year are caed Money Market Instruments)
medum term (notes): maturtes between sx to tweve years;
ong term (bonds): maturtes greater than tweve years.
Coupon|edt|
The coupon s the nterest rate that the ssuer pays to the hoder. Usuay ths
rate s xed throughout the fe of the bond. It can aso vary wth a money
market ndex, such as LIBOR, or t can be even more exotc. The name
"coupon" arose because n the past, paper bond certcates were ssued
whch had coupons attached to them, one for each nterest payment. On the
due dates the bondhoder woud hand n the coupon to a bank n exchange
for the nterest payment. Interest can be pad at dherent frequences:
generay sem-annua, .e. every 6 months, or annua.
Bond ssued by the Dutch East Inda Company n 1623
Yed|edt|
The yed s the rate of return receved from nvestng n the bond. It usuay
refers ether to
the current yed, or runnng yed, whch s smpy the annua nterest
payment dvded by the current market prce of the bond (often the cean
prce), or to
the yed to maturty or redempton yed, whch s a more usefu measure of
the return of the bond, takng nto account the current market prce, and the
amount and tmng of a remanng coupon payments and of the repayment
due on maturty. It s equvaent to the nterna rate of return of a bond.
Credt Ouaty|edt|
The "quaty" of the ssue refers to the probabty that the bondhoders w
receve the amounts promsed at the due dates. Ths w depend on a wde
range of factors. Hgh-yed bonds are bonds that are rated beow nvestment
grade by the credt ratng agences. As these bonds are more rsky than
nvestment grade bonds, nvestors expect to earn a hgher yed. These bonds
are aso caed |unk bonds.
Market Prce|edt|
The market prce of a tradeabe bond w be nuenced amongst other thngs
by the amounts, currency and tmng of the nterest payments and capta
repayment due, the quaty of the bond, and the avaabe redempton yed of
other comparabe bonds whch can be traded n the markets.
The prce can be quoted as cean or drty. ("Drty" ncudes the present vaue
of a future cash ows ncudng accrued nterest. "Drty" s most often used
n Europe. "Cean" does not ncude accrued nterest. "Cean" s most often
used n the U.S.|7| )
The ssue prce at whch nvestors buy the bonds when they are rst ssued
w typcay be approxmatey equa to the nomna amount. The net
proceeds that the ssuer receves are thus the ssue prce, ess ssuance fees.
The market prce of the bond w vary over ts fe: t may trade at a premum
(above par, usuay because market nterest rates have faen snce ssue), or
at a dscount (prce beow par, f market rates have rsen or there s a hgh
probabty of defaut on the bond).
Others|edt|
Indentures and Covenants - An ndenture s a forma debt agreement that
estabshes the terms of a bond ssue, whe covenants are the causes of
such an agreement. Covenants specfy the rghts of bondhoders and the
dutes of ssuers, such as actons that the ssuer s obgated to perform or s
prohbted from performng. In the U.S., federa and state securtes and
commerca aws appy to the enforcement of these agreements, whch are
construed by courts as contracts between ssuers and bondhoders. The
terms may be changed ony wth great dmcuty whe the bonds are
outstandng, wth amendments to the governng document generay
requrng approva by a ma|orty (or super-ma|orty) vote of the bondhoders.
Optonaty: Occasonay a bond may contan an embedded opton; that s, t
grants opton-ke features to the hoder or the ssuer:
Caabty - Some bonds gve the ssuer the rght to repay the bond before
the maturty date on the ca dates; see ca opton. These bonds are referred
to as caabe bonds. Most caabe bonds aow the ssuer to repay the bond
at par. Wth some bonds, the ssuer has to pay a premum, the so-caed ca
premum. Ths s many the case for hgh-yed bonds. These have very strct
covenants, restrctng the ssuer n ts operatons. To be free from these
covenants, the ssuer can repay the bonds eary, but ony at a hgh cost.
Putabty - Some bonds gve the hoder the rght to force the ssuer to repay
the bond before the maturty date on the put dates; see put opton. These are
referred to as retractabe or putabe bonds.
ca dates and put dates-the dates on whch caabe and putabe bonds can
be redeemed eary. There are four man categores.
A Bermudan caabe has severa ca dates, usuay concdng wth coupon
dates.
A European caabe has ony one ca date. Ths s a speca case of a
Bermudan caabe.
An Amercan caabe can be caed at any tme unt the maturty date.
A death put s an optona redempton feature on a debt nstrument aowng
the benecary of the estate of a deceased bondhoder to put (se) the bond
(back to the ssuer) at face vaue n the event of the bondhoder's death or
ega ncapactaton. Aso known as a "survvor's opton".
snkng fund provson of the corporate bond ndenture requres a certan
porton of the ssue to be retred perodcay. The entre bond ssue can be
qudated by the maturty date. If that s not the case, then the remander s
caed baoon maturty. Issuers may ether pay to trustees, whch n turn ca
randomy seected bonds n the ssue, or, aternatvey, purchase bonds n
open market, then return them to trustees.
Types|edt|
Bond certcate for the state of South Carona ssued n 1873 under the
state's Consodaton Act.
Raroad obgaton Moscow-Kev-Voronezh
The foowng descrptons are not mutuay excusve, and more than one of
them may appy to a partcuar bond.
Fxed rate bonds have a coupon that remans constant throughout the fe of
the bond. A varaton are stepped-coupon bonds, whose coupon ncreases
durng the fe of the bond.
Foatng rate notes (FRNs, oaters) have a varabe coupon that s nked to a
reference rate of nterest, such as LIBOR or Eurbor. For exampe the coupon
may be dened as three month USD LIBOR + 0.20%. The coupon rate s
recacuated perodcay, typcay every one or three months.
Zero-coupon bonds (zeros) pay no reguar nterest. They are ssued at a
substanta dscount to par vaue, so that the nterest s ehectvey roed up
to maturty (and usuay taxed as such). The bondhoder receves the fu
prncpa amount on the redempton date. An exampe of zero coupon bonds
s Seres E savngs bonds ssued by the U.S. government. Zero-coupon bonds
may be created from xed rate bonds by a nanca nsttuton separatng
("strppng oh") the coupons from the prncpa. In other words, the separated
coupons and the na prncpa payment of the bond may be traded
separatey. See IO (Interest Ony) and PO (Prncpa Ony).
Hgh-yed bonds (|unk bonds) are bonds that are rated beow nvestment
grade by the credt ratng agences. As these bonds are more rsky than
nvestment grade bonds, nvestors expect to earn a hgher yed.
Convertbe bonds et a bondhoder exchange a bond to a number of shares of
the ssuer's common stock. These are known as hybrd nvestments, because
they combne equty and debt features.
Exchangeabe bonds aows for exchange to shares of a corporaton other
than the ssuer.
Inaton-ndexed bonds (nkers) (US) or Index-nked bond (UK), n whch the
prncpa amount and the nterest payments are ndexed to naton. The
nterest rate s normay ower than for xed rate bonds wth a comparabe
maturty (ths poston brey reversed tsef for short-term UK bonds n
December 2008). However, as the prncpa amount grows, the payments
ncrease wth naton. The Unted Kngdom was the rst soveregn ssuer to
ssue naton nked gts n the 1980s. Treasury Inaton-Protected Securtes
(TIPS) and I-bonds are exampes of naton nked bonds ssued by the U.S.
government.
Recept for temporary bonds for the state of Kansas ssued n 1922
Other ndexed bonds, for exampe equty-nked notes and bonds ndexed on
a busness ndcator (ncome, added vaue) or on a country's GDP.
Asset-backed securtes are bonds whose nterest and prncpa payments are
backed by underyng cash ows from other assets. Exampes of asset-backed
securtes are mortgage-backed securtes (MBS's), coaterazed mortgage
obgatons (CMOs) and coaterazed debt obgatons (CDOs).
Subordnated bonds are those that have a ower prorty than other bonds of
the ssuer n case of qudaton. In case of bankruptcy, there s a herarchy of
credtors. Frst the qudator s pad, then government taxes, etc. The rst
bond hoders n ne to be pad are those hodng what s caed senor bonds.
After they have been pad, the subordnated bond hoders are pad. As a
resut, the rsk s hgher. Therefore, subordnated bonds usuay have a ower
credt ratng than senor bonds. The man exampes of subordnated bonds
can be found n bonds ssued by banks, and asset-backed securtes. The
atter are often ssued n tranches. The senor tranches get pad back rst, the
subordnated tranches ater.
Covered bonds are backed by cash ows from mortgages or pubc sector
assets. Contrary to asset-backed securtes the assets for such bonds reman
on the ssuers baance sheet.
Perpetua bonds are aso often caed perpetutes or 'Perps'. They have no
maturty date. The most famous of these are the UK Consos, whch are aso
known as Treasury Annutes or Undated Treasures. Some of these were
ssued back n 1888 and st trade today, athough the amounts are now
nsgncant. Some utra-ong-term bonds (sometmes a bond can ast
centures: West Shore Raroad ssued a bond whch matures n 2361 (.e.
24th century) are vrtuay perpetutes from a nanca pont of vew, wth the
current vaue of prncpa near zero.
Bearer bond s an omca certcate ssued wthout a named hoder. In other
words, the person who has the paper certcate can cam the vaue of the
bond. Often they are regstered by a number to prevent counterfetng, but
may be traded ke cash. Bearer bonds are very rsky because they can be
ost or stoen. Especay after federa ncome tax began n the Unted States,
bearer bonds were seen as an opportunty to concea ncome or assets.|8|
U.S. corporatons stopped ssung bearer bonds n the 1960s, the U.S.
Treasury stopped n 1982, and state and oca tax-exempt bearer bonds were
prohbted n 1983.|9|
Regstered bond s a bond whose ownershp (and any subsequent purchaser)
s recorded by the ssuer, or by a transfer agent. It s the aternatve to a
Bearer bond. Interest payments, and the prncpa upon maturty, are sent to
the regstered owner.
A government bond, aso caed Treasury bond, s ssued by a natona
government and s not exposed to defaut rsk. It s characterzed as the
safest bond, wth the owest nterest rate. A treasury bond s backed by the
"fu fath and credt" of the reevant government. For that reason, for the
ma|or OECD countres ths type of bond s often referred to as rsk-free.
Pacc Raroad Bond ssued by Cty and County of San Francsco, CA. May 1,
1865
Muncpa bond s a bond ssued by a state, U.S. Terrtory, cty, oca
government, or ther agences. Interest ncome receved by hoders of
muncpa bonds s often exempt from the federa ncome tax and from the
ncome tax of the state n whch they are ssued, athough muncpa bonds
ssued for certan purposes may not be tax exempt.
Bud Amerca Bonds (BABs) are a form of muncpa bond authorzed by the
Amercan Recovery and Renvestment Act of 2009. Unke tradtona US
muncpa bonds, whch are usuay tax exempt, nterest receved on BABs s
sub|ect to federa taxaton. However, as wth muncpa bonds, the bond s
tax-exempt wthn the US state where t s ssued. Generay, BABs oher
sgncanty hgher yeds (over 7 percent) than standard muncpa bonds.
|10|
Book-entry bond s a bond that does not have a paper certcate. As
physcay processng paper bonds and nterest coupons became more
expensve, ssuers (and banks that used to coect coupon nterest for
depostors) have tred to dscourage ther use. Some book-entry bond ssues
do not oher the opton of a paper certcate, even to nvestors who prefer
them.|11|
Lottery bonds are ssued by European and other states. Interest s pad as on
a tradtona xed rate bond, but the ssuer w redeem randomy seected
ndvdua bonds wthn the ssue accordng to a schedue. Some of these
redemptons w be for a hgher vaue than the face vaue of the bond.
War bond s a bond ssued by a country to fund a war.
Sera bond s a bond that matures n nstaments over a perod of tme. In
ehect, a $100,000, 5-year sera bond woud mature n a $20,000 annuty
over a 5-year nterva.
Revenue bond s a speca type of muncpa bond dstngushed by ts
guarantee of repayment soey from revenues generated by a speced
revenue-generatng entty assocated wth the purpose of the bonds. Revenue
bonds are typcay "non-recourse", meanng that n the event of defaut, the
bond hoder has no recourse to other governmenta assets or revenues.
Cmate bond s a bond ssued by a government or corporate entty n order to
rase nance for cmate change mtgaton- or adaptaton-reated pro|ects or
programmes.
Dua currency bonds |12|
Reta bond s a type of corporate bond wth very ow nterest rates mosty
desgned for ordnary nvestors n the ndustry.|13| They have become
partcuary attractve snce the London Stock Exchange (LSE) aunched an
order book for reta bonds.|14|
Soca mpact bonds are an agreement for pubc sector enttes to pay back
prvate nvestors after meetng vered mproved soca outcome goas that
resut n pubc sector savngs from nnovatve soca program pot pro|ects.
Foregn currences|edt|
Some companes, banks, governments, and other soveregn enttes may
decde to ssue bonds n foregn currences as t may appear to be more
stabe and predctabe than ther domestc currency. Issung bonds
denomnated n foregn currences aso gves ssuers the abty to access
nvestment capta avaabe n foregn markets. The proceeds from the
ssuance of these bonds can be used by companes to break nto foregn
markets, or can be converted nto the ssung company's oca currency to be
used on exstng operatons through the use of foregn exchange swap
hedges. Foregn ssuer bonds can aso be used to hedge foregn exchange
rate rsk. Some foregn ssuer bonds are caed by ther ncknames, such as
the "samura bond". These can be ssued by foregn ssuers ookng to
dversfy ther nvestor base away from domestc markets. These bond ssues
are generay governed by the aw of the market of ssuance, e.g., a samura
bond, ssued by an nvestor based n Europe, w be governed by |apanese
aw. Not a of the foowng bonds are restrcted for purchase by nvestors n
the market of ssuance.
Eurodoar bond, a U.S. doar-denomnated bond ssued by a non-U.S. entty
outsde the U.S|15|
Bakava bond, a bond denomnated n Turksh Lra and ssued by a domestc
or foregn entty n the Turksh market|16|
Yankee bond, a US doar-denomnated bond ssued by a non-US entty n the
US market
Kangaroo bond, an Austraan doar-denomnated bond ssued by a non-
Austraan entty n the Austraan market
Mape bond, a Canadan doar-denomnated bond ssued by a non-Canadan
entty n the Canadan market
Samura bond, a |apanese yen-denomnated bond ssued by a non-|apanese
entty n the |apanese market
Urdash bond, a non-yen-demonnated bond sod to |apanese reta nvestors.
Shbosa Bond, a prvate pacement bond n |apanese market wth dstrbuton
mted to nsttutons and banks.
Shogun bond, a non-yen-denomnated bond ssued n |apan by a non-
|apanese nsttuton or government|17|
Budog bond, a pound sterng-denomnated bond ssued n London by a
foregn nsttuton or government.
Matroshka bond, a Russan roube-denomnated bond ssued n the Russan
Federaton by non-Russan enttes. The name derves from the famous
Russan wooden dos, Matroshka, popuar among foregn vstors to Russa
Arrang bond, a Korean won-denomnated bond ssued by a non-Korean entty
n the Korean market|18|
Kmch bond, a non-Korean won-denomnated bond ssued by a non-Korean
entty n the Korean market|19|
Formosa bond, a non-New Tawan Doar-denomnated bond ssued by a non-
Tawan entty n the Tawan market|20|
Panda bond, a Chnese renmnb-denomnated bond ssued by a non-Chna
entty n the Peope's Repubc of Chna market|21|
Dm sum bond, a Chnese renmnb-denomnated bond ssued by a Chnese
entty n Hong Kong. Enabes foregn nvestors forbdden from nvestng n
Chnese corporate debt n manand Chna to nvest n and be exposed to
Chnese currency n Hong Kong.|22|
Huaso bond, a Chean peso-denomnated bond ssued by a non-Chean
entty n the Chean market.|23|
Tha Baht bond, ssued by The Mnstraty of Fnance of The Lao Peope's
Democratc Repubc (Lao PDR) nto the Thaand market.|24|
Bond vauaton|edt|
See aso: Bond vauaton
At the tme of ssue of the bond, the nterest rate and other condtons of the
bond w have been nuenced by a varety of factors, such as current market
nterest rates, the ength of the term and the credtworthness of the ssuer.
These factors are key to change over tme, so the market prce of a bond
w vary after t s ssued. The market prce s expressed as a percentage of
nomna vaue. Bonds are not necessary ssued at par (100% of face vaue,
correspondng to a prce of 100), but bond prces w move towards par as
they approach maturty (f the market expects the maturty payment to be
made n fu and on tme) as ths s the prce the ssuer w pay to redeem the
bond. Ths s referred to as "Pu to Par". At other tmes, prces can be above
par (bond s prced at greater than 100), whch s caed tradng at a premum,
or beow par (bond s prced at ess than 100), whch s caed tradng at a
dscount. Most government bonds are denomnated n unts of $1000 n the
Unted States, or n unts of 100 n the Unted Kngdom. Hence, a deep
dscount US bond, seng at a prce of 75.26, ndcates a seng prce of
$752.60 per bond sod. (Often, n the US, bond prces are quoted n ponts
and thrty-seconds of a pont, rather than n decma form.) Some short-term
bonds, such as the U.S. Treasury b, are aways ssued at a dscount, and pay
par amount at maturty rather than payng coupons. Ths s caed a dscount
bond.
The market prce of a bond s the present vaue of a expected future nterest
and prncpa payments of the bond dscounted at the bond's yed to
maturty, or rate of return. That reatonshp s the denton of the
redempton yed on the bond, whch s key to be cose to the current
market nterest rate for other bonds wth smar characterstcs. (Otherwse
there woud be arbtrage opportuntes.) The yed and prce of a bond are
nversey reated so that when market nterest rates rse, bond prces fa and
vce versa.
The market prce of a bond may be quoted ncudng the accrued nterest
snce the ast coupon date. (Some bond markets ncude accrued nterest n
the tradng prce and others add t on separatey when settement s made.)
The prce ncudng accrued nterest s known as the "fu" or "drty prce".
(See aso Accrua bond.) The prce excudng accrued nterest s known as the
"at" or "cean prce".
The nterest rate dvded by the current prce of the bond s caed the current
yed (ths s the nomna yed mutped by the par vaue and dvded by the
prce). There are other yed measures that exst such as the yed to rst ca,
yed to worst, yed to rst par ca, yed to put, cash ow yed and yed to
maturty.
The reatonshp between yed and term to maturty (or aternatvey between
yed and the weghted mean term aowng for both nterest and capta
repayment) for otherwse dentca bonds s caed a yed curve. The yed
curve s a graph pottng ths reatonshp.
Bond markets, unke stock or share markets, sometmes do not have a
centrazed exchange or tradng system. Rather, n most deveoped bond
markets such as the U.S., |apan and western Europe, bonds trade n
decentrazed, deaer-based over-the-counter markets. In such a market,
market qudty s provded by deaers and other market partcpants
commttng rsk capta to tradng actvty. In the bond market, when an
nvestor buys or ses a bond, the counterparty to the trade s amost aways a
bank or securtes rm actng as a deaer. In some cases, when a deaer buys
a bond from an nvestor, the deaer carres the bond "n nventory", .e. hods
t for hs own account. The deaer s then sub|ect to rsks of prce uctuaton.
In other cases, the deaer mmedatey reses the bond to another nvestor.
Bond markets can aso dher from stock markets n that, n some markets,
nvestors sometmes do not pay brokerage commssons to deaers wth
whom they buy or se bonds. Rather, the deaers earn revenue by means of
the spread, or dherence, between the prce at whch the deaer buys a bond
from one nvestor-the "bd" prce-and the prce at whch he or she ses the
same bond to another nvestor-the "ask" or "oher" prce. The bd/oher
spread represents the tota transacton cost assocated wth transferrng a
bond from one nvestor to another.
Investng n bonds|edt|
Bonds are bought and traded mosty by nsttutons ke centra banks,
soveregn weath funds, penson funds, nsurance companes, hedge funds,
and banks. Insurance companes and penson funds have abtes whch
essentay ncude xed amounts payabe on predetermned dates. They buy
the bonds to match ther abtes, and may be compeed by aw to do ths.
Most ndvduas who want to own bonds do so through bond funds. St, n
the U.S., neary 10% of a bonds outstandng are hed drecty by househods.
The voatty of bonds (especay short and medum dated bonds) s ower
than that of equtes (stocks). Thus bonds are generay vewed as safer
nvestments than stocks, but ths percepton s ony partay correct. Bonds
do suher from ess day-to-day voatty than stocks, and bonds' nterest
payments are sometmes hgher than the genera eve of dvdend payments.
Bonds are often qud - t s often fary easy for an nsttuton to se a arge
quantty of bonds wthout ahectng the prce much, whch may be more
dmcut for equtes - and the comparatve certanty of a xed nterest
payment twce a year and a xed ump sum at maturty s attractve.
Bondhoders aso en|oy a measure of ega protecton: under the aw of most
countres, f a company goes bankrupt, ts bondhoders w often receve
some money back (the recovery amount), whereas the company's equty
stock often ends up vaueess. However, bonds can aso be rsky but ess rsky
than stocks:
Fxed rate bonds are sub|ect to nterest rate rsk, meanng that ther market
prces w decrease n vaue when the generay prevang nterest rates rse.
Snce the payments are xed, a decrease n the market prce of the bond
means an ncrease n ts yed. When the market nterest rate rses, the
market prce of bonds w fa, reectng nvestors' abty to get a hgher
nterest rate on ther money esewhere - perhaps by purchasng a newy
ssued bond that aready features the newy hgher nterest rate. Ths does
not ahect the nterest payments to the bondhoder, so ong-term nvestors
who want a specc amount at the maturty date do not need to worry about
prce swngs n ther bonds and do not suher from nterest rate rsk.
Bonds are aso sub|ect to varous other rsks such as ca and prepayment
rsk, credt rsk, renvestment rsk, qudty rsk, event rsk, exchange rate
rsk, voatty rsk, naton rsk, soveregn rsk and yed curve rsk. Agan,
some of these w ony ahect certan casses of nvestors.
Prce changes n a bond w mmedatey ahect mutua funds that hod these
bonds. If the vaue of the bonds n ther tradng portfoo fas, the vaue of the
portfoo aso fas. Ths can be damagng for professona nvestors such as
banks, nsurance companes, penson funds and asset managers (rrespectve
of whether the vaue s mmedatey "marked to market" or not). If there s
any chance a hoder of ndvdua bonds may need to se hs bonds and "cash
out", nterest rate rsk coud become a rea probem (conversey, bonds'
market prces woud ncrease f the prevang nterest rate were to drop, as t
dd from 2001 through 2003. One way to quantfy the nterest rate rsk on a
bond s n terms of ts duraton. Ehorts to contro ths rsk are caed
mmunzaton or hedgng.
Bond prces can become voate dependng on the credt ratng of the ssuer
- for nstance f the credt ratng agences ke Standard & Poor's and Moody's
upgrade or downgrade the credt ratng of the ssuer. An unantcpated
downgrade w cause the market prce of the bond to fa. As wth nterest
rate rsk, ths rsk does not ahect the bond's nterest payments (provded the
ssuer does not actuay defaut), but puts at rsk the market prce, whch
ahects mutua funds hodng these bonds, and hoders of ndvdua bonds
who may have to se them.
A company's bondhoders may ose much or a ther money f the company
goes bankrupt. Under the aws of many countres (ncudng the Unted States
and Canada), bondhoders are n ne to receve the proceeds of the sae of
the assets of a qudated company ahead of some other credtors. Bank
enders, depost hoders (n the case of a depost takng nsttuton such as a
bank) and trade credtors may take precedence.
There s no guarantee of how much money w reman to repay bondhoders.
As an exampe, after an accountng scanda and a Chapter 11 bankruptcy at
the gant teecommuncatons company Wordcom, n 2004 ts bondhoders
ended up beng pad 35.7 cents on the doar|ctaton needed|. In a
bankruptcy nvovng reorganzaton or recaptazaton, as opposed to
qudaton, bondhoders may end up havng the vaue of ther bonds reduced,
often through an exchange for a smaer number of newy ssued bonds.
Some bonds are caabe, meanng that even though the company has agreed
to make payments pus nterest towards the debt for a certan perod of tme,
the company can choose to pay oh the bond eary. Ths creates renvestment
rsk, meanng the nvestor s forced to nd a new pace for hs money, and the
nvestor mght not be abe to nd as good a dea, especay because ths
usuay happens when nterest rates are fang.
Bond ndces|edt|
See aso: Bond market ndex
A number of bond ndces exst for the purposes of managng portfoos and
measurng performance, smar to the S&P 500 or Russe Indexes for stocks.
The most common Amercan benchmarks are the Barcays Capta Aggregate
(ex Lehman Aggregate), Ctgroup BIG and Merr Lynch Domestc Master.
Most ndces are parts of fames of broader ndces that can be used to
measure goba bond portfoos, or may be further subdvded by maturty
and/or sector for managng specazed portfoos.