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 Bonds
Govcrnment and rorporate brnds
h Bonds are loans to local and national governments and to large companies. The holders
of bonds generally receive fixed interest payments, once or fwice a year' and get their
money - known as the principal - back on a given maturity date. This is the date when
the loan ends.
Governments issue bonds to raise money and they are considered to be a risk-free
investment. In Britain government bonds are known as gilt-edged stock or just gilts. In
the US they are called Treasury notes, which have a maturity of 2-10 years' and Tieasury
bonds, which have a maturity of 10-30 years. (There are also short-term Treasury bills
which have a different function: see Units 25 and 27.)
Companies issue bonds, called corporate bonds, because they can usually pay less interest
to bondholders than they would have to pay if they raised the same money by a bank
loan. These bonds are generally safer than shares, because if a company cannot repay its
debts it can be declared bankrupt. If this happens, the creditors can force the company to
stop doing business, and sell its assets to repay them. In this way, bondholders will
probably get some of their money back.
Borrowers - the companies issuing bonds - are given credit ratings by credit agencies such
as Standard & Poor{ and Moody's. This means that they are graded, or rated' according
to their ability ro repay the loan to the bondholders. The highest grade (AAA or Aaa)
means that there is almost no risk that the borrower will default - fail to pay interest or
to repay the principal. Lower grades (e.g. Baa, BBB, C, etc.) mean an increasing risk of
the borrowei becoming insolvent - unable to pay interest or repay the capital'

re Prices and yields

Bonds are traded by banks which act as market makers for their customers' quoting bid
and offer prices with a very small spread or difference befween them. (See Unit 30) The
I
price of bànds varies inversely with interest rates. This means that if interest rates rise' so
that new borrowers have to pay a higher rate, existing bonds lose value' If interest rates
fall, existing bonds paying a higher interest rate than the market rate increase in value.
Consequenily the yield of a bond - how much income it gives - depends on its purchase
price ai well as its coupon or interest rate. There are also floating-rate notes - bonds
whose interest rate varies with market interest rates.

re ûthnr typts af bonds

!7hen interest rates are high, some companies issue convertible shares or convertibles'
which are bonds that the owner can later change into shares. Convertibles pay lower
interest rates than ordinary bonds, because the buyer gets the chance of making a profit
with the convertible oPtion'
There are also zero coupon bonds that pay no interest but are sold at a big discount on
their par value, which is 100%, and repaid at 100o/o at maturity. Because they pay no
interÂt, their owners don't receive money every year (and so don't have to decide how to
reinvest it); instead they make a capital gain at maturity'
Bonds with a low credit rating (and a high chance of default), but paying a high interest
rate. are called iunk bonds. Some of these are known as fallen angels - bonds of
companies that were previously in a good financial situation, while others are issued to
finance leveraged buyouts. (See Unit 40)

BrE: convertible share; AmE: convertible bond

j
 33. 1 Match the words in the box with the definitions
below. Look at A and B opposite to help
you.
couPon maturity date
creditrating principal
gilt-edged stock Treasury bonds
default Tîeasury notes
insolvenr yield

1 the amount of capital making up a loan

ry 2 an estimation of a borrower,s ,olu.rr.y or ability to pay
debts
3 bonds issued by the British governmenr
4 non-payment of interest or à loan at the scheduled
time
5 the day when a bond has to be reoaid
\L
G long-term bonds issued by the American governmenr
7 the amount of interest that a bond Days
B medium-term (2-10 year) bonds issueâ by
the American government
9 the rate of income an investor receives frâ^ ur.;;;;;"
10 unable to pay debts

ch rl 2 -\re the following statements true or false? Find reasons

t for your answers in A, B and c opposite.
I Bonds are repaid at 100o/o when they mature, unless the
borrower is insolvent.
2 Bondholders are guaranteed to g., nil ,h.i,
3 AAA bonds are a very safe investment. -;;;L;.k ii".o-pu'y goes bankrupt.
4 A. bond payils 5olo interest would gain in value
if interest rates rose to 6u/o.
5 The price of floating-rare nores do.-sn't vary
very -;.;;L;.u"se they always pay market
rnterest rates.
6 The owners of convertibles have to change them
into shares.
7 some bonds do not pay interest, but are repaid
at above their selring price.
8 funk bonds have a high credit rating, and a ,"lutiu.ly ro*
.hurr.. of default.
3l 3 -\nswer the questions. Look at A, B and C opposite
to help you.
1 \X/hich is the safest for an invesror?
A a corporate bond B a junk bond C a government bond
2 \X/hich is the cheapest way for a company
to raise money?
-
A a bank loan B an ordinaiy bond- d I convertible
3 \X/hich gives the highest potential rerurn to an
investor?
A a corporate bond B a junk bond C a government bond
a \x/hich is the most profitable for an investor if
interest rates
A a Treasury bond B a floating-rate note ë- u 1-.."r,rry
'se?
note
 Capital Markets (II)
Achievements, seldom credited to their source, are the result of unspeakable
drudgery and worries.
Richard Wagner

Bond market
The bond market refers to people and entities involved in buying and selling of bonds.
What matters is the:
 The quantity traded
 The prices of the transactions over time
 The financial strength of the participants in a bond market
The bond market is also called:
 The credit market
 The debt market
A bond is a debt security:
 The issuer owes the bondholder a debt
 S/he is obliged to repay the principal and interest
 Bonds are generally issued for a fixed term
The issuer = the borrower
The bond holder = the lender
Yield = the annual rate of return when investing in bonds
Interest = coupon
Principal = the amount of a loan the borrower has to pay back when the loan gets to
maturity
The interest rate that the issuer of a bond must pay is influenced by a variety of
factors:
 Current market interest rates
 The length of the term
 The creditworthiness of the issuer
 Bonds are traded mostly by institutions like:
 Pension funds
 Insurance companies
 Mutual companies
 Banks

N. B.: the U.S. Treasury uses the word bond or Treasury bond only for their issues
with a maturity longer than ten years and calls issues between one and ten years notes or
Treasury notes. T-bills or simply bills are the bonds issued with a maturity less then one year.
The correspondent for Treasury bonds in the UK is gilt-edged securities or just gilts.

The distinction disappeared in the rest of the world, but still market participants use
bonds for big issues offered to a large public and notes for smaller issues sold to a limited
number of investors. Bills are usually used by the government to regulate the money supply
by selling to and buying them from commercial banks.

Issuers
 National Governments
 Public administrations
 Local authorities (municipalities)
 Companies
 Supranational agencies such as the European Investment Bank

Zero coupon bonds

Inflation linked bonds

Asset-backed bonds
TYPES OF BONDS

Floating rate bonds

Junk bonds

Convertible bonds

Callable bonds

Perpetual bonds (perpetuities)

Subordinated bonds

Fixed rate bonds

1. Match the types of bonds with their correspondent definitions:

 They have a coupon that remains constant throughout the life of the bond.
 They have a coupon that is linked to a money market index. The coupon is re-
established every three months.
  They can be converted, on the maturity date, into different kinds of securities, usually
common stock in the company that issued the bonds.
 They are rated below investment grade by the credit rating agencies. As these bonds
are relatively risky, investors expect to earn a higher yield.
 They do not pay any interest. They are traded at a substantial discount from par. The
bondholder receives the principal on the maturity date. The coupons are separated
from the final principal payment of the bond and traded independently
 These kinds of bonds have the principal indexed to inflation. The interest rate is
relatively low. However, as the principal amount grows, the payments increase with
inflation.
 These are bonds whose interest and principal are backed by underlying cash flows
from other assets.
 They have a lower priority than other bonds of the issuer in case of liquidation. As the
expectation that you get paid back is lower, the risk is higher. Therefore, they have a
low credit rating.
 They have no maturity date.
 In this case, the company has agreed to pay earlier the principal plus interest towards
the debt.

2. Fill in using: underwrite/ing, primary, syndicate, auctioned, internal, external,

secondary
Bonds are issued by governments or other public authorities, companies and supranational
institutions in the….markets. The most common process of issuing bonds is through….. One
or more banks, forming a…. , ….. the bonds, and sell them to their customers. Government
bonds are typically….. Bonds enable the issuer to finance long-term investments
with….funds.

3. Fill in using: interest rate, price, market interest rate, yield, present, interest, current
yield, principal, rise, fall, premium, discount, maturity, par, face, converge.
The market value of a bond can vary after it is issued. Because of these differences in market
value, bonds are priced in terms of percentage of…..value. Bonds are not necessarily issued
at….. (100% of….value, corresponding to a price of 100), but all bond prices…..to…..at the
moment before they reach….. At other times, prices can either….(bond is priced at greater
than 100), which is called trading at a……, or…..(bond is priced at less than 100), which is
called trading at a…...
The market price of a bond is the….value of all future….and…..payments of the bond
discounted at the bond’s…., or rate of return. The…..represents the current..…..for bonds with
similar characteristics. The…and….of a bond are inversely related so that when…., bond …..
generally fall and vice versa.
The…..adjusted for the current….of the bond is called the “…..” (this is the nominal yield
multiplied by the par value and divided by the price).
4. Which of the following statements are true or false?
 Bonds are generally viewed as safer investments than stocks.
 Bonds do suffer from less day-to-day volatility.
 Bonds’ interests are higher than the dividends the same company may choose to pay.
 Bonds are not so liquid.
 If a company goes bankrupt, its bondholders will often receive some money back.
5. Fill in using: rise, fall, drop, higher, lower, decrease
Fixed rate bonds are subject to interest rate risk, meaning they will….in value when the
generally prevailing interest rate…. When the market’s interest rates…., then the market price
for bonds will…., reflecting investors’ improved ability to get a good interest rate perhaps by
purchasing a recently issued bond that already features the newly…..interest rate. This….in
the bond’s market price does not affect the interest payments to the bondholder at all, so long-
term investors need not worry about price sways in their bonds.
6. In each case, which of the two statements is true?
 a. Bond prices can become volatile if one of the rating agencies like Standard & Poor’s
or Moody’s upgrades or downgrades the credit rating of the issuer.
b. Bond prices can become volatile if one of the rating agencies like Standard &
Poor’s or Moody’s downgrades the credit rating of the issuer.
 a. A downgrade can cause the market price of the bond to increase.
b. A downgrade can cause the market price of the bond to decrease.
 a. The interest rate risk does not affect the bond’s interest payments.
b. The interest rate risk affects the bond’s interest payments
 a. A company’s bondholders may lose all their money if the company goes bankrupt.
b. A company’s bondholders do not risk losing all their money if the company goes
bankrupt.
 a. Government bonds are usually referred to as risk-free bonds, because the
government can raise taxes to pay the principal.
b. Government bonds are usually referred to as risk-free bonds, because the
government can print more money to pay the principal.
 a. Investing in bonds also means assuming the inflation risk, i.e. the principal repaid at
maturity will have less purchasing power than anticipated if the inflation is higher than
expected.
b. Investing in bonds also means assuming the inflation risk, i.e. the principal repaid at
maturity will have less purchasing power than anticipated if the inflation is lower than
expected.
 a. Some European developing countries such as Bulgaria have been rated in February
2006 at BBB+.
b. Some European developing countries such as Romania have been rated in February
2006 at BBB+.
Equities and bonds
7. Add appropriate words to the following statements:
 Issuing shares for the first time is called……a company.
 Profitable companies are…...on major Stock Exchanges.
 The value written on a share is its…………….
 The interest paid by a bond is called its………
 Most bonds have a…………..interest rate.
 A bond’s…….depends on the purchasing power.
 Bonds valued at above 100% are described as being………
 …….display bid and offer prices for specific numbers of specific securities, and if
these prices are met, they will immediately buy for or sell from their own accounts.
 …….is the difference between the nominal value and the market price of a share.

Task
Investigate the Romanian bond market.
Which of the following is currently issuing bonds? Provide examples.
a. public administration
b. government
c. companies
d. cities