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Bond Evaluation

Bond Evaluation. CCIG. What Are Bonds?. A debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as an issuer

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Bond Evaluation

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  1. Bond Evaluation CCIG

  2. What Are Bonds? • A debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as an issuer • In return, the issuer provides you with a bond in which it promises to pay a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures, or comes due.

  3. Why Invest in Bonds? • Predictable income stream. • Portfolio diversification. • Great investment choice for IRA’s and 401k’s (retirement planning). • Either saving for your children’s college education or for a new home, fixed income can do the magic.

  4. Assessing Risk • Risk is proportional to return. • Safer investments offer lower returns. Hence Treasury rate is the lowest bond rate you can obtain on the bond market. • Key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status.

  5. Bond Price

  6. Bond Interest Rate • Interest that can be fixed, floating or payable at maturity. • Fixed rate bonds carry any interest rate that is established when the bonds are issued (expressed as a percentage of the face amount) with semiannual interest payments • Floating rate bonds carries a rate which is reset periodically in line with interest rates on Treasury bills, the London Interbank Offered Rate (LIBOR), or some other benchmark interest-rate index. • Zero coupon bonds: Investor receives one payment at maturity that is equal to the purchase price (principal) plus the total interest earned.

  7. Time to Bond Maturity • The longer a bond's term, the more its price may be affected by interest rate fluctuations. Hence, investors expect to be compensated for taking that extra risk. • This relationship can be best demonstrated by drawing a line between the yields available on similar bonds of different maturities, from shortest to longest. Such a line is called a yield curve.

  8. Yield curve

  9. How To Invest (1) • Individual Bonds • Most individual bonds are bought and sold in the over-the-counter (OTC) market, although some corporate bonds are also listed on the New York Stock Exchange. • The OTC market comprises securities firms and banks that trade bonds; brokers or agents, who buy and sell bonds on behalf of customers in response to specific requests; and dealers, who keep an inventory of bonds to buy and sell. 

  10. How To Invest (2) • Bond Funds • Bond funds, like stock funds, offer professional selection and management of a portfolio of bonds for a fee. • Through a bond fund, an investor can diversify risks across a broad range of issues and opt for a number of other conveniences, such as the option of having interest payments either reinvested or distributed periodically. • Some funds are designed to follow a market, in general or a specified index of bonds. These are often referred to as index or passive funds. • Other funds are actively managed according to a stated objective, with bonds purchased and sold at the discretion of a fund manager.

  11. Investment Strategy Considerations • Active vs. Passive. • Diversification: achieved in any number of ways. • 1/ Bond Type: mix of high-yield and investment-grade bonds. • 2/ Laddering: purchase securities of various maturities to mitigate interest rate risks. E.g. you might invest equal amounts in bonds maturing in 2, 4, 6, 8 and ten years. In two years, when the first bonds mature, you would reinvest the money in a 10-year maturity, maintaining the ladder. • Bond Swap: • The sale of a block of bond swaps and the purchase of another block of similar market value. Swaps may be made to achieve many goals, including establishing a tax loss, upgrading credit quality, extending or shortening maturity, etc. • The most common swap is done to achieve tax savings by converting a paper loss into an actual loss that could partially or fully offset other capital gains or income.

  12. Who issues bonds? • Government • Treasury • STRIPS • TIPS • Municipal (Tax Free Status) • Corporations

  13. Rating Agencies • Moody • S&P • Fitch

  14. 3 Rates – Do Not Confuse • YTM – Yield to Maturity (IRR) • Coupon Rate • Current Yield

  15. Risk • Interest Rate Risk • Longevity Risk • Inflation Risk

  16. Application • Tax deductible of interest expenses for businesses • No control over voting rights • Negative impact on cash flow

  17. Example

  18. Reference websites • Bond calculators : www.investinginbondseurope.org • Bonds investing: www.investinginbonds.com

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