Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
Session-31
Introduction to Bond Analysis
31.1 What is Bond?
Bond is a financial instrument which pays a fixed amount of interest periodically to
the holder of record. It also repays a fixed amount of principal at the date of maturity.
Generally bonds are issued by the government, states, municipalities and corporations. Some
bonds do not pay interest, but all bonds require a repayment of principal. When an investor
buys a bond, he/she becomes a creditor of the issuer. However, the buyer does not gain any
kind of ownership rights to the issuer, unlike in the case of equities. On the other hand bond
holder has a greater claim on an issuers income than a shareholder in the case of financial
distress.
The important intrinsic features of bond are coupon, maturity, principal value, and the
type of ownership are. The coupon of a bond indicates the income that the bond investor will
receive over the life (or holding period) of the issue. This is known as interest income or
coupon income. The term to maturity specifies the date or the number of years before a bond
matures (or expires). The principal, or par value, of an issue represents the original value of
the obligation. This is generally stated in Rs1, 000 increments from Rs1, 000 to Rs. 25,000 or
more. Bonds also differ in terms of ownership. With a bearer bond, the holder, or bearer, is
the owner, so the issuer keeps no record of ownership. Interest from a bearer bond is obtained
by clipping coupons attached to the bonds and sending them to the issuer for payment. In
contrast, the issuers of registered bonds maintain records of owners and pay the interest
directly to them.
Money Market This market deals with the short-term issues that mature within one
year
Notes This market comprises the intermediate-term issues that mature between one
and ten years
Bonds This market deals with the long-term obligations with maturity greater than
ten years
1
All these bond markets vary across the countries on the basis of the term to maturity of the
instruments available in that market.
example, a bond can be issued with a feature that the interest rate on this bond is 1 percent
above the bank rate. The rates of interest are always in tune with the market rates because of
this special feature of floating. Other type of bond available in the market is indexed bonds.
In these bonds the principal and coupon payments are linked to the market index like
inflation and price index. Index bonds are attractive to investors as they are safer than the
convention bonds in terms of real interest rate risk and inflation expectation risk. Indexed
bonds apart from providing safety to investors also provide a steady interest income from
investment while keeping the principal intact. Because both coupon and principal payments
of an indexed bond are adjusted for inflation, an investor can count on the steady purchasing
power provided by the coupon interest payment during the life of the bond. Further when an
indexed bond matures, its principal has the same purchasing power as when it was invested.
Junk bonds are high yield bonds issued by companies and are considered highly speculative
because of high risk of default.
Callable bonds give the right to the issuer to redeem the bond the bond prior to its
maturity to date at a specified call price. The bonds are beneficial to its issuer when the
coupon interest paid by the bond is higher than the prevailing interest rates. Basically the
company can issue the same bonds at a lower interest rate leading to lower cost of financing.
Puttable bonds can be redeemed prior to maturity at the initiative of the bondholder. These
bonds are more advantageous to the investors as they get an opportunity to redeem their
bonds when the prevailing market interest rate is more than the coupon interest on bonds.
This feature enables the investors to unlock their current investment and invest in more
profitable avenues.
Issued on the basis of maturity: (i) Short Term Maturity: - Security with maturity
period less than one year, (ii) Medium Term: - Security with maturity period between
1year and 5 year, (iii) Long Term Maturity: -Such securities have maturity period
more than 5 years, (iv) Perpetual: - Security with no maturity. Currently, in India
Banks issue perpetual bond.
It can also be issued on the basis of coupon: (i) Fixed Rate Bonds:-have a coupon that
remains constant throughout the life of the bond, (ii) Floating Rate Bonds: - Coupon
rates are reset periodically based on benchmark rate, (iii) Zero-coupon Bonds no
coupons are paid. The bond is issued at a discount to its face value, at which it will be
redeemed. There are no intermittent payments of interest
Categorized on the basis on Option (i) Bond with call option: - This feature gives a
bond issuer the right, but not the obligation, to redeem his issue of bonds before the
bond's maturity at predetermined price and date, (ii) Bond with put option: - This
feature gives bondholders the right but not the obligation to sell their bonds back to
the issuer at a predetermined price and date. These bonds generally protect investors
from interest rate risk.
These are classified on the basis of redemption: (i) Bonds with single redemption: - In
this case principal amount of bond is paid at the time of maturity only, (ii) Amortising
Bonds: - A bond, in which payment made by the borrower over the life of the bond,
includes both interest and principal, is called an amortizing bond.
Instruments
Maturity
Investors
Central
Bank
T-Bills
91/364 days
RBI
State
Government
Dated
Securities
5-13 Years
PSUs
Bonds
5-10 Years
Corpoartes
Debentures
1-12 Years
Commercial
Banks
Certificate
of Deposits
31.5
It is the contract between the issuer and the bond holders specifying the issuers legal
requirements. A trustee acting on behalf of the bond holders ensures that all the indenture
provisions are met including the timely payment of interest and principal.
Pi, t +1 + Int i, t
Pi, t
cv = convertible
zr = zero coupon
Notes - intermediate-term issues that mature between one and ten years
Treasury Bills
ii.
iii.
Certificate of Deposits
Commercial Paper
Commodity-Linked Bonds
Pi, t +1 + Int i, t
Pi, t
Reference Index
Maturity Date
Coupon: Indicates the income that the bond investor will receive over the life of the
issue.
Term to Maturity: The date or the number of years before a bond matures.
Types of Ownership
Bearer Bond
Registered Bond
Types of Issues
Callable
Non callable
Deferred call