# Principles of Finance – Bond overview

##### What are bonds?

In this segment i will introduce the topic of bonds bonds are basically an iou if you think of them like the iou or something that you would loan somebody else or that some borrow money from somebody else bonds of the same way it’s just a corporation borrowing money from you if you borrow money from somebody there’s three things you want to know how much are you

They borrowing or are you borrowing in a bond that’s called the par value the amount to the borrowing and simout this owed it than the truly the bond when it has to get paid back normally par values are a thousand dollars what else do on no bond well you wanna know how much you’re borrowing you i don’t know how much interest you have to pay interest is the cost of

Borrowing money for a bond we call that the coupon rate so it would be an interest rate and the payment that gets made is whatever that coupon rate is say 10% of the par value so that’s the par value is a thousand and your coupon rates 10% the binodal paid \$100 a year or typically a bond pays interest twice a year semi-annually so it’ll pay that \$100 in two pieces

\$500 fifth sorry \$50 twice a year gives you \$100 which is the 10% of the thousand dollar bond and finally the third thing you wanna know when you borrow money is when you pay it back those are the three things that determine the price of a bond the par value the amount of the loan the coupon rate interests that gets paid and the maturity when that bond has to get

Paid back not an interesting thing to note is when you are talking about par value if you go look up bond prices on the internet they’re normally shown as a integer like 125 as i show here in the slide those are 125 percent off the par value which in this case would mean one thousand two hundred and fifty dollars is what the bond would be priced at well talk about

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That a little later in terms of why bonds are priced higher or lower than the par value the bonds have a certain feature may have a certain feature and that they may be called callable callable means that the person can pay back the bond early if they want they can redeem the bond why would you do that well if interest rates fall like they have been really 20/20

Interest rates are falling well i can borrow the money at a cheaper rate so i’ll pay back the bonds that have high rates and borrow money and lower rates bonds can be considered to have a claim on assets that’s important what that means is if the company defaults the bondholders are the ones that get paid back first before the stockholders receive anything now

With several types of bonds as corporate bonds corporate bonds come in really two basic flavors debentures debentures a promise to pay back an iou there’s little collateral nothing a secured bond is one that has collateral you can think of say exxon might sell a secured bond we which is secured by maybe an oil tanker so if they go into default the bondholders can

Have claim to the oil tanker and therefore get paid back why would a company sell secured bonds well they would sell secured bonds because they’re less risky and therefore they won’t pay less interest bondholders will require less interest they require less a smaller rate of return because the bond is safer because it’s secured government government bonds come in

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Two flavors us government bonds us treasury bonds these are bonds that are have a maturity date greater than two years most popular one you’ll hear about is the 10-year treasury bond but we look at the tenure and the 30-year bonds as well municipal bonds are bonds that are issued by state and local governments they come in two flavors one is a general obligation

Bond then just means that they promise to pay back so if bridgewater wants to build a library they might issue a general obligation bond they won’t have the money sitting around so they go borrow it the way they pay it back just through taxes so the interest that gets paid on the municipal bond is paid by taxes there’s also revenue bonds sometimes the state of

Municipality might build something that generates revenue a great example is the parkway parkway has tolls on it those tolls were used to generate revenue to pay back the bonds interesting side fact is the parkway bonds have all been paid back and yet we still have the tolls why state loves to get money we have euro bonds those the bonds that are issued in dollar

Denominated bonds but might be issued by another country sovereign bonds sighs sorry sovereign debt sovereign debt is basically government that norway issues bonds or sweden issues bonds we call it sovereign debt convertible bonds are bonds which can be converted at the owners request typically into common stock and then finally we have mortgage backed bonds these

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Were the famous things that cost such happen such havoc in 2008 the bonds have risk and their companies are trying to reach the risk of buttons you’ll see standard & poor’s famous for the s&p 500 but companies like movies and fitch also rate companies they all have a little bit of different scale but it all looks pretty much like it looks in this slide the

Best rated the least risky bonds are triple-a and double-a a triple b that will be b all the way down to d which means default now there’s an important significant mark between these and that is bonds that are b being below are considered junk bonds they are considered very high risk triple b and above are considered to be investment to grade bonds now it’s important

To know that b people are junk bonds because they are also called in the industry high-yield bonds makes them sound real good right i’m gonna get a high-yield i’m gonna get a lot of money out of these bonds why are they paying a lot of money because they’re very risky why would somebody hold a risky bond well they pay a high interest so be very careful when you

Hear somebody call oh high yield i’m getting high yield yes but you are also taking on high risk and they’re called junk bonds many organizations are prohibited by law from investing in junk bonds pension funds for example are not allowed to invest in junk bonds alright next we will look at how we evaluate price out bonds

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Principles of Finance – Bond overview By Klinger Business