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Bond Markets

Bond Markets. Primarily over-the-counter transactions with dealers connected electronically Extremely large number of bond issues, but generally low daily volume in single issues Makes getting up-to-date prices difficult, particularly on small company or municipal issues

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Bond Markets

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  1. Bond Markets • Primarily over-the-counter transactions with dealers connected electronically • Extremely large number of bond issues, but generally low daily volume in single issues • Makes getting up-to-date prices difficult, particularly on small company or municipal issues • Treasury securities are an exception • Bond yield information is available online. One good site is Bonds Online • http://www.bondsonline.com/ • Follow the “bond search,” “search/quote center,” “corporate/agency bonds,” and “composite bond yields” links • Observe the yields for various bond types, and the shape of the yield curve.

  2. Corporate Bond Price Reporting • Coupon rate: 8.375% • Coupon payment per year = $83.75 = 0.08375 X 1,000 • Bond matures on July 15, 2033 • Trading volume = $763,528,000 (Face value of bonds traded) • Quoted price: 100.641% of face value, so if face value is 1,000, the price is $1,006.41. • Bond prices are quoted as a percent of par, just as the coupon is quoted as a percent of par. • The bond’s yield (8.316%) is 362 basis points (3.62%) above the comparable maturity Treasury bond yield (30-year Treasury bond yield). • 100 basis points = 1% • Current yield = 8.322% • Computed as annual coupon divided by current price ($83.75 / $1,006.41 = 8.32%)

  3. Corporate Bond Price Reporting – Continued • How can we determine the yield on GM bond? • To do that we use another TI BA II PLUS worksheet – BOND • Date entry: mm.ddyy • 2ND BOND • 2ND CLR WORK • 01.1305 ENTER (Settlement date.) • 8.375 ENTER (Annual coupon interest rate in percent form.) • 07.1533 ENTER (Maturity date.) • 100 ENTER (Face value entered as 100. If the bond has a call price it can be set to that.) • ACT (“ACT” is actual day count. Can be changed to “360” by using 2ND SET) • 2/Y (Coupon payment per year. Can be changed to “1/Y” by using 2ND SET) • Since we are computing yield (YLD) • 100.641 ENTER (Non-negative price of the bond as a % of face value.) • CPT (Go back to “YLD” to compute.) • AI (“AI” is Accrued Interest as dollar amount per face value amount.) • DUR (“DUR” is Duration of the bond – average time it takes to recover the market price.)

  4. Clean and Dirty Price of a Bond • How much do you think you will pay for the previous bond per $100 par value? • Price a buyer would pay will include “Accrued Interest” (AI) if a bond is purchased after the last coupon but before the next coupon payment • This is because a seller is entitled to receive some of the next coupon payment based on the fraction of six month period she owned it. • A quotation excluding AI is called “Clean Price” • What you pay for the bond is called “Dirty Price” • Dirty Price = Clean Price + Accrued Interest • Dirty Price = $100.641 + $4.142 = $104.783 • AI is quite close to 8.375 / 2 = 4.1875 since we are short by two days to make it a full six month period (1/13/05 vs. 1/15/05) • 4.1875 × 178/180 = 4.141 • You pay Dirty Price (Clean Price + AI) to the seller and get the next coupon in two days in full

  5. More on Clean and Dirty Price of a Bond • Why do dealers quote clean price then? • Clean prices excludes price drops of bonds due to a coupon payment. • This drop can also be observed for stock when there is a dividend payment. • Clean prices change not because of a coupon payment but rather because of a change in general direction of interest rates or a change in the credit quality of borrower

  6. Treasury Bond Price Reporting • Coupon rate = 9% • Matures in November 2018 • Bid price (Dealer’s Bid – dealer is willing to pay) is 145 and 25/32 percent of par value. • 145:25 = (145+25/32)% of par value = 145.78125% of par value • If you want to sell $100,000 par value T-bonds, the dealer is willing to pay 1.4578125(100,000) = $145,781.25 • Ask price (Dealer’s Ask – dealer is willing to receive) is 145 and 26/32 percent of par value. • 145:26 = (145+26/32)% of par value = 145.8125% of par value • If you want to buy $100,000 par value T-bonds, the dealer is willing to sell them for 1.458125(100,000) = $145,812.50 • The difference between the bid and ask prices is called the bid-ask spread and it is how the dealer makes money. • Note that Ask Price is higher than Bid Price. Why is that? • The price changed by 22/32 percent or $687.50 for a $100,000 worth of T-bonds (22/32)% of par. • (22/32)% = 0.6875% and 0.6875% X $100,000 = $687.50. • The yield based on the ask price is 4.51%

  7. Treasury Bond Price Reporting – Continued • If the date of quotation is January 14, 2005 and exact maturity date is 11/15/2018 what is the yield based on ask price? • 2ND BOND • 2ND CLR WORK • 01.1405 ENTER (Settlement date.) • 9.000 ENTER (Annual coupon interest rate in percent form.) • 11.1518 ENTER (Maturity date.) • 100 ENTER (Face value entered as 100. If the bond has a call price it can be set to that.) • ACT (“ACT” is actual day count. Can be changed to “360” by using 2ND SET) • 2/Y (Coupon payment per year. Can be changed to “1/Y” by using 2ND SET) • Since we are computing yield (YLD) • 145.8125 ENTER (Non-negative price of the bond as a % of face value.) • CPT (Go back to “YLD” to compute.

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