1. Fixed Income Securities and Debt Markets
Chapter 7

2. Debt vs. Equity Debt: Equity: Contractual , obligation Fixed term
Interest
The Issuer can be sued for default of payments
Equity:
Right to eliminate dividends, even on preferred shares
Can’t be sued for reduction or elimination of dividends

3. Bonds A Bond - is a publicly traded debt Different types of Bonds:
Treasury
Zero coupon
Corporate
In US - Municipal
In Canada:
Provincial
City

4. Bonds Rating agencies: Principal borrowers: Payments on a Bond: Fitch
Moody
Principal borrowers:
Governments
Corporations
Payments on a Bond:
Income payment is called – Coupon
Principal is called – Par Value

5. Bonds Notations: The coupon rate is fixed over maturity
rc – coupon rate, usually paid semi-annually
YTM – y - expected rate of return for a Bond investor (per annum, compounded semi-annually)
M – Par Value (principal)
n - # of 6-months periods to maturity
n/2 – # of years to maturity
C - coupon
The coupon rate is fixed over maturity
Yield to maturity (YTM or y) is market determined

6. Bonds
Coupon: Value of Bond:

7. Bonds There are 3 rates in the bond market: Coupon rate
Yield to maturity (YTM , y)
Current yield

8. YTM ≤ Current Yield ≤ Coupon rate (OTE)
Bonds
Premium bond:
Price > Par Value
YTM ≤ Current Yield ≤ Coupon rate (OTE)

9. Bonds Other Things Equal (OTE):
Interest rates in the economy don’t change
Credit worthiness of borrower doesn’t change
Flat term structure of yields
Can’t “ride down” the yield curve
Coupon reinvestment at yield rate

10. YTM ≥ Current Yield ≥ Coupon Rate
Bonds
Discount bond:
Price < Par Value
YTM ≥ Current Yield ≥ Coupon Rate

11. Bonds Bond Pricing: Invoice Price = Bond Value =
= Quoted Price + Accrued Interest
Notations:
IP – Invoice Price = Total expenditure to buy a bond
QP – Quoted Price = Price used for trading
AI = Accrued Interest = the buyer of a bond must pay the seller “fraction” of a coupon period since last coupon times the amount of the upcoming coupon
IP = QP + AI

12. Bonds Risks: Price Risk Reinvestment Risk Default Risk Inflation
Fisher’s Relationship:
(1 + y) = (1 + r*)*(1 + ∏)
r* - real rate of interest per annum
∏ - expected rate of inflation per annum