Zero coupon bonds
Pay no coupons Make only one payment: the face value at maturity All benefit to the buyer comes from the change in value from current price today to par value at maturity Example: a ZCB has face value $500 and matures in 10 years
Feature of bonds
Issuer: US Treasury/Government agencies . States, municipalities Corporations Foreign governments (sovereign debt) Term (number of years to maturity): Short (less than a year) :Ttibills, CDs, Commercial paper Long (more than a year) Ttibonds, corporate bonds Price vs. par value (or face value) : par bond (issue price=face value) discount bond (issue price < face value) premium bond (issue price > face value) Where do ZCBs fall?
Main features of bonds
Seniority and security Senior, junior/subordinated Covenants: Restrictions on additional issues, dividends, and other corporate actions Option provisions Callability: After a certain period, issuer has the right to pay back the loan before it matures. Puttability: After a certain period, bondholder has the right to demand payment of the loan before maturity Convertibility: After a certain period, bondholder has the right to exchange the bond for shares in the issuer
Bonds issued
"Primary market" Government securities: normally auctioned.
http://www.newyorkfed.org/aboutthefed/fedpoint/fed41.html Corporate securities, federal agencies' debt, municipal bonds, mortgagetibacked securities: typically underwritten by investment banks. : Underwriters: a syndicate of investment banks "Firm commitment" or "Best effort" . "Road show" Book building Filing with SEC EDGAR: see IBM's 424B5 filing dated 2017ti01ti26
Traded bonds
"Secondary market" Network of dealers . Like Merrill Lynch, Goldman Sachs, Citigroup . Quote "bids" and "asks", but not for much . Market is "thin": hard to sell/buy : FINRA TRACE You and I will never buy a single bond : Bond mutual funds
Price
Nothing different: fair value of an asset is the PV of its expected cashflows discounted at the OCC Find the expected cashflow Discount by the OCC Riskless bonds: .E.g., those issued by the US government A one year risktifree semiannualtipay coupon bond with face value $100 has a coupon rate of 12%. The riskfree interest rate is 10% EAR. What is the bond's price? First get the expected cashflows What happens if the bond price is not the fair value? Arbitrage : Henceforth we assume no arbitrage opport