Bonds.pdf

Bonds.pdf

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  Government Bonds A governmentbond is a debt security issued by a government to support government spending and obligations. Government bonds can pay periodic interest payments called coupon payments. Government bonds issued by national governments are often considered low-risk investments since the issuing government backs them. Government bonds are issued by governments to raise money to finance projects or day-to-day operations. The U.S. Treasury Department sells the issued bonds during auctions throughout the year. Some Treasury bonds trade in the secondary market. Individual investors, working with a financial institution or broker, can buy and sell previously issued bonds through this marketplace. Treasuries are widely available for purchase through the U.S. Treasury, brokers, as well as exchange- traded funds, which contain a basket of securities.  A government bond represents debt that is issued by a government and sold to investors to support government spending.  Some government bonds may pay periodic interest payments. Other government bonds do not pay coupons and are sold at a discount instead.  Government bonds are considered low-risk investments since the government backs them. There are various types of bonds that are offered by the U.S. Treasury are considered to be among the safest in the world.  Because of their relative low risk, government bonds typically pay low interest rates. Merits and Demerits of Government Bonds As with all investments, government bonds provide both benefits and disadvantages to the bondholder. On the upside, these debt securities tend to return
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  a steady streamof interest income. However, this return is usually lower than other products on the market due to the reduced level of risk involved in their investments. Merits  Pay a steady interest income return  Low risk of default for U.S. bonds  Exempt from state and local taxes  A liquid market for reselling  Assessable through mutual funds. Demerits  Offer low rates of return  Fixed income falls behind with rising inflation  Carry risk when market interest rates increase  Default and other risks on foreign bonds Zero Coupon Bond A zero-coupon bond, also known as an accrual bond, is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value. Some bonds are issued as zero-coupon instruments from the start, while other bonds transform into zero-coupon instruments after a financial institution strips them of their coupons, and repackages them as zero-coupon bonds. Because they offer the entire payment at maturity, zero-coupon bonds tend to fluctuate in price, much more so than coupon bonds.  A zero-coupon bond is a debt security instrument that does not pay interest.
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   Zero-coupon bondstrade at deep discounts, offering full face value (par) profits at maturity.  The difference between the purchase price of a zero-coupon bond and the par value indicates the investor's return. Merits One of the big advantages of zero coupon bonds is that they have higher interest rates than other corporate bonds. In order to attract investors to this type of long- term proposition, companies have to be willing to pay higher interest rates. This means that if you are alright with not receiving regular interest payments, you can actually make more money in the long run with zero coupon bonds. This type of investment is also great for investors who have long-term specific objectives in mind. This type of bond gives you the assurance that you will know exactly how much it will be worth at a specific date in the future. Demerits One of the biggest problems with investing in zero coupon bonds is that you have to pay taxes on interest. This means that you will need to pay income taxes on interest that you are not actually receiving. Another problem with zero coupon bonds is that they have a higher default risk than traditional bonds. The reason behind this is that companies do not have to make regular interest payments to the investors. Floating Rate Bond A floating-rate note (FRN) is a debt instrument with a variable interest rate. The interest rate for an FRN is tied to a benchmark rate. Benchmarks include the U.S. Treasury note rate, the Federal Reserve funds rate—known as the Fed funds rate—
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  the London InterbankOffered Rate (LIBOR), or the prime rate. Floating rate notes or floaters can be issued by financial institutions, governments, and corporations in maturities of two-to-five years. There's no guarantee that the FRN's rate will rise as fast as interest rates in a rising- rate environment. It all depends on the performance of the benchmark rate. As a result, an FRN bondholder can still have interest rate risk meaning the bond's rate underperforms the overall market. Since the bond's rate can adjust to market conditions, an FRN's price tends to have less volatility or price fluctuations. Traditional fixed-rate bonds typically slide when rates rise because existing bondholders are losing out by holding a product returning a lower-rate.  A floating-rate note is a bond that has a variable interest rate.  The interest rate is tied to a short-term benchmark rate, such as LIBOR or the Fed funds rate, plus a quoted spread, or rate that holds steady.  Many floating-rate notes have quarterly coupons, meaning that they pay interest four times a year, but some pay monthly, semiannually, or annually.  FRNs appeal to investors because they can benefit from higher interest rates since the rate on the floater adjusts periodically to current market rates. Merits  Floating rate notes allow investors to benefit from rising rates as the FRN's rate adjusts to the market  FRNs are impacted less by price volatility  FRNs are available in U.S. Treasuries and corporate bonds
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  Demerits  FRNs maystill have interest rate risk if market rates rise to a greater extent than the rate resets  FRNs can have default risk if the issuing company or corporation can't pay back the principal  If market interest rates fall, the FRN rates may fall as well  FRNs typically pay a lower rate than their fixed-rate counterparts What Economic Factors Influence Corporate Bond Yields? The economic factors that influence corporate bond yields are interest rates, inflation, the yield curve, and economic growth. Corporate bond yields are also influenced by a company's own metrics such as credit rating and industry sector. All of these factors affect corporate bond yields and exert influence on each other. The pricing of corporate bond yields is a multivariate, dynamic process in which there are always competing pressures.  Corporate bond yields indicate the relative riskiness of the issuing company but are also influenced by macroeconomic factors.  Economic growth and low inflation are positive for corporations, and so they have a downward effect on bond yields.  When economies grow, however, target interest rates may be increased as inflation rises, which puts positive pressure on yields. Economic Growth Economic growth, typically measured by a rising GDP, is bullish for corporations as it leads to increased revenues and profits for companies, making it easier for them to borrow money and service debt, which leads to a reduced risk of default and, in turn, lower yields.
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  However, extended periodsof economic growth lead to inflation risk and upward pressure on wages. Economic growth leads to increased competition for labor and diminished excess capacity. Inflation Higher wages due to inflation begin to eat away at profit margins, making them more vulnerable to slippage in economic growth. Inflation also raises the prices of things in the economy in general terms, and as things become pricier the ability to pay for them rises, and so credit risk increases that is a positive pressure on yields. Interest Rates Inflation risk also leads central banks to raise target interest rates. When the risk- free rate of return rises, corporate bond yields must rise as well to compensate. The higher yields add to increased costs, creating even more vulnerability to economic stumbles. Thus, yields can skyrocket as costs mount if the economy slips into a recession and revenues fall; investors begin to price in an increased chance of default. When growth concerns begin to dwarf inflationary risks, the central bank cuts interest rates, leading to downward pressure on corporate bond yields. Decreases in the risk-free rate of return make all yield-generating instruments more attractive.