Can you answer Jeff D’s question about Bonds?:

What happens to exisitng bond prices when the government decides to issue new treasury bonds?

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Debentures are loans, secured by a corporation, municipality or government. Bonds and debentures are instruments that provide for a maturity at which time the principal will be repaid. In addition to the payback of principal, the borrower will pay interest at stated intervals, usually semi-annually.

There are four common types of bonds and debentures:

1. Government bonds and debentures

2. Corporate bonds and debentures

3. Domestic bond funds

4. International bond funds.

In this article, we will discuss the overall concepts of bonds and debentures

a) Security

*Bonds are considered as secured debt. If the borrower defaults, the assets can be seized to satisfy the bondholder.

* Debentures, on the other hand, are unsecured, but are supported by the general credit of the corporation, municipality or government issuing the bonds. When issued by governments, there is the ability to raise taxes to honor their repayment obligation.

b) Contract features

Bonds and debentures are prominent players in the debt market. They come in 3 maturity durations.

i. Short Term: three years or less.

ii. Medium Term: three to five years.

iii. Long Term: more than ten years

and the most common features in the contract are

i. Identify the Term to maturity.

ii. Show interest payment structure.

iii. Provide a coupon rate.

iv. Indicate the valuation and pricing.

In bonds and debentures, the issuer is the borrower and the lender is the bond owner. when bonds are sold on the secondary market, the ownership changes. Each bond that is sold requires the presentation of a prospectus. Prospectus is a document that lists the name of the issuer, bond features, assets securing the loan and other details. In addition, a prospectus also gives the company background, purpose of the bonds and other information of value to the buyer.

There are types of bonds, but the two most common are Bearer Bonds and Registered Bonds.

i. Bearer bonds are owned by the holder and are issued with coupons for interest payments.The holder may sell the bond at any time.

ii. Registered bonds are registered with the issuer who keeps a record of the owner. They may only be sold by the registrant and interest payments are made by check to the registered owner.

Other Corporate Bond types include

i. Redeemable bonds.

ii. Callable bonds.

iii. Retractable bonds.

For bonds of these types, the principal amount borrowed may be paid back anytime prior to maturity and thirty days notice is generally required before exercising the option.

c) Bond and Taxation

If a bond is sold before maturity, it can be sold using any of the following three methods

i. At Par: yield will be identical to the coupon rate.

ii. At Discount: yield will be less than the coupon rate.

iii. At a Premium: yield will be more than the coupon rate.

Bonds are taxed on a bond year basis and attract taxation in two ways

i. 1. Capital Gains. The adjusted cost base of a bond is the purchase price plus any sales commission less any accrued interest paid. Any profit is considered a capital gain and any loss is considered a capital loss.

ii. Coupon rate or interest earned

d) Government bonds

Government bonds are debentures. The investment risk is nil due to the federal government’s ability to increase taxes which will generate additional income to make bond payments. These bonds and debentures are subject only to interest rate risks. Government bonds can be used to satisfy the following investment objectives:

i. Provide income.

ii. Ensure safety of principal.

iii. Very Liquid.

They are taxed on a bond year basis and are eligible for any deferred tax saving plan.

I hope this information will help. If you need more information, you can read the complete series of the above subject at my home page:

http://lifeanddisabitityinsuranceunderwriter.blogspot.com/

http://financialinvesting09.blogspot.com/

http://financialinvesting13.blogspot.com/

All rights reserved. Any reproducing of this article must have all the links intact.



Thanks to Kyle J. Norton for contributing this article to our Bonds blog:

Unclaimed Premium Bonds

As its name suggests, a high-yield bond (also known as a junk bond) is a bond that offers high yields in exchange for a higher risk of defaulting (i.e. a greater returns from interest rather than principal).

In the U.S., there are three principal credit rating agencies: S&P, Moody’s, and Fitch Ratings. These companies rate bonds according to the probability of default together with the probability of not receiving interest and principal subsequent to a default (i.e. credit risk).

For example the scale used by S&P and Fitch is: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D (sometimes consisting of sub-categories). Bonds that are rated AAA by S&P are considered “prime, maximum safety”, and most government bonds fall into this category.

A credit rating BBB or higher indicates that the bond is investment grade, while a credit rating lower than BBB indicates that the bond is non-investment grade, or junk (hence the alternative title of high-yield bonds).

Some institutional investors (e.g. pension funds) are prohibited from investing in bonds below a particular grade level.

For companies whose bonds have been rated investment grade, a downgrade to “junk” status can be a difficult situation. Not only will newly issued bonds now require significantly higher interest payments, but the relatively narrow market for junk bond issues can make them higher to sell. A bond with a credit rating that has dropped below investment grade is commonly referred to as a “fallen angel”.

High-yield bonds play an important role in some investment strategies. A common strategy involving high-yield bonds is merger arbitrage. In a merger, an acquirer would issue junk bonds to help finance an acquisition, after which the acquirer would use the acquired target’s cash flow to pay the debt over a period of time.

For many industries, junk bonds are an important source of capital.

Some recommended reading: Beyond Junk Bonds by Glenn Yago and Susan Trimbath. This book is a very comprehensive guide to the high-yield market in general. Includes case studies of actual firms and securities in the industry, as well as comparisons to the private/public equity, and fixed income markets.

Another highly recommended title, written by an authority on distressed debt and bankruptcy, is: Bankruptcy, Credit Risk, and High Yield Junk Bonds by Edward I. Altman. Includes a dedicated section to High Yield “Junk Bonds and Distressed Securities, and articles from other scholarly contributors around the world.



Thanks to Gary Spitz for contributing this article to our Bonds blog:

Cashing In Savings Bonds