Chapter 14 In-Class Notes

Background on Bonds Bonds: long-term debt securities issued by government agencies or corporations that are collateralized by assets Par value: the amount returned to the investor at the maturity date when the bond is due Bond features Callable, convertible, extendible, retractable Discount  bond price < par value Premium  bond price > par value 14-2Copyright © 2009 Pearson Education Canada

Types of Bonds Types of bonds Government of Canada bonds Federal crown corporation bonds Provincial bonds Municipal bonds Corporate bonds 14-3Copyright © 2009 Pearson Education Canada

Other Fixed-Income Products Other fixed-income products Short-term debt securities (T-Bills, banker’s acceptances, commercial paper) Mortgage backed securities (MBSs) Strip bonds Real return bonds 14-4Copyright © 2009 Pearson Education Canada

Return from Investing in Bonds Impact of Interest Rate Movements Bond coupon rate < current coupon rate on similar bonds, sell bond at discount Bond coupon rate > current coupon rate on similar bonds, sell bond at premium Tax Implications Interest income  results from coupon payments Capital gain or loss  results from cost price being more or less than market price when sold 14-5Copyright © 2009 Pearson Education Canada

Valuing a Bond Bond valuation Present value of future cash flows, including coupon payments and principal payment at maturity 14-6Copyright © 2009 Pearson Education Canada

Risk from Investing in Bonds Default risk  the risk that the borrower of funds will not repay the creditors Call risk  the risk that a callable bond will be called Interest rate risk  the risk that a bond’s price will decline in response to an increase in interest rates The longer the term to maturity, the greater the interest rate risk 14-7Copyright © 2009 Pearson Education Canada

Bonds Investment Strategies Interest rate strategy: Selecting bonds based on interest rate expectations Passive strategy: Investing in a diversified portfolio of bonds that are held for a long period of time e.g., bond laddering Maturity matching strategy: Investing in bonds that will generate payments to match future expenses 14-8Copyright © 2009 Pearson Education Canada