Bond (finance)

Interest-bearing securities is the collective term for all forms of interest-bearing or - bearing securities (such as debentures, bonds, debentures, bonds, debentures, internationally also: Bond or Debenture ), which are usually used for long -term debt financing and investment.

  • 3.1 issuers
  • 3.2 Method of Issue
  • 3.3 markets 3.3.1 National
  • 3.3.2 International
  • 6.1 bonds with option rights
  • 6.2 Special forms
  • 6.3 Special designations
  • 9.1 review
  • 9.2 Example Review 9.2.1 Situation 1
  • 9.2.2 Situation 2

Definition

A fixed-income asset Title (derived also called fixed income product from the Anglo-American ) is a legal claim to blame:

In contrast to the share of the buyer of a corporate bond does not acquire a share in the equity of the company, but give him credit, ie debt.

The term fixed income securities is not related to the type of interest, but to the legal status of financial security holder. Fixed income securities include income bonds, ABS, convertible bonds and bonds with warrants. Similarly, among the fixed rate bonds floaters, index-linked bonds and zero coupon bonds, although these do not provide a fixed periodic interest rate.

Certificate

The instrument consists of jacket and bow. The shell represented the creditor's claim. The sheet consists of coupons that are used to enforce the income claims ( eg interest), and optionally a renewal coupon ( Talon ).

Trade

Income securities can be bought and sold on the bond market at the current price. However, bonds must not be traded on the stock exchange in most countries, that is, they are not mandatory exchange-trading (see also: Off-exchange trading ).

The bond is considered to be rather low-risk form of investment, as it has defined interest as well as a fixed repayment, and is secured depending on the configuration. Institutional investors ( eg, insurance ) are obligated to invest a large proportion of the managed funds in securities with high credit ratings, with the choice often falls on fixed-income securities. There are also bonds that deliberately contain a higher risk for a higher return (interest ) promise (eg corporate bonds).

Bonds are usually issued as a bearer bond, since the simplest tradability is. The owner of the bond is thus simultaneously the creditors. However, the design as name, order or Rektapapier is conceivable.

Professional trade

Bonds are traded on exchanges. Trading on exchanges is in determining the price but relatively insignificant because the traded volumes (amounts ) compared to the OTC (over the counter ), the direct trading between banks, are minimal.

The quotation of individual bonds is different. Some bonds are traded after return ( eg Swedish government bonds SGB, Australian government bonds and Japanese government bonds, JGB ), others are traded with courses (eg German Bunds DBR, Austrian government bonds RAGB, British government bonds Gilts ). In the United States government bonds ( Treasuries) with 32nd (1 /32) are quoted (eg 101-16 101 corresponds to 16/32 = 101.50 ).

The default value is on European government bonds normal T 3, with U.S. Treasuries T 1, depending on the settlement system in Japan T 2 ( Furukai - Furiketsu ) or T 4 ( Toruku ).

In recent years, electronic trading systems established themselves in more and more types of bonds. Today, the vast majority of sales in liquid European government bonds no longer via telephone, but via electronic trading platforms such Bond Vision, Tradeweb, Eurex Bonds or Bloomberg Bond trading is handled.

Functions

By denomination of fixed-rate title - often amounts to several million units of currency (eg U.S. dollars or Euros ) - in a variety of bonds at a nominal value of 50, 100, 1000 or 10,000 currency units is a batch sizes transformation. This makes the bonds for a large group of investors attractive, as well as part amounts may be acquired and not only the total issue size. Bonds fulfill a mobilizing function.

By standardizing the bonds in a higher fungibility can be achieved. In this way, the different commitment periods of the issuer and the creditor can harmonize. This temporal transformation function has its basis in liquid secondary markets.

Issuers and issues

Issuers

As editor of bonds are:

  • Public bonds are issued by the federal government ( eg government bonds and other Federal securities ), as well as state and local public bodies. Federal and state governments finance their deficits in the country or the federal budget on public bonds.
  • Bank bonds and mortgage bonds issued by credit institutions which thereby obtain their funds for the medium-and long -term financing of its lending business.
  • Corporate bonds (including corporate bonds ) are bearer bonds and thus a form of financing. A bond may be emitted from both an individual and a company at home and abroad, that is being issued for purchase by investors. The investors in the bond may also be living at home and abroad.

In Austria and Germany, most bonds issued by banks and the government are published, while many companies issue bonds in the U.S.. The reason for this lies in the fact that companies in Europe to raise capital more often by self-financing or obtain loans from commercial banks, partially funded by the public sector.

Method of Issue

The issuance of bonds can be performed as a self -issued or foreign mission. When the stranger mission a bank or a placement consortium acts as a mediator.

The emission can be performed as a private placement or public offering. In the public offering, the following forms are common in bonds:

  • Private sale: The sale is for a fixed price to the termination of the proceedings or to sell (example: Federal Treasury Bonds)
  • Launch for public subscription: Investors make a binding declaration within a period, what amount of loan they are willing to accept. However, you have no right to the subscribed securities. If demand exceeds the offer ( oversubscription ), the Issuer may, at its discretion allocate ( scaling down ).
  • Tender procedures: Similar to a auction; however, indicate the artist what amount they are willing to buy at what price. The issuer then uses all the commandments which not less than one ( chosen by the issuer) minimum rate. In this case the issue size is not fixed from the beginning, but will be adjusted depending on the amount of bids. One distinguishes the American ( each bidder pays his own bid ) from the Dutch procedures (all pay the same price ). This method is used in federal government securities.
  • Tap issue: More current mission under the same conditions.

Bonds can at par (= 100 %), are issued below par or above par. Below or above par, it means that on the issue of a new bond, a discount (discount ) or a fee ( premium) is determined by which the issue price exceeds the face value or below.

Markets

National

A domestic bond is placed on the national bond market. It involves the issue of a bond of a domestic issuer. It is emitted in the home currency and using a domestic consortium, with the rules of the home country must be respected. An example of this is a federal loan. Their performance measures of the German bond index.

Internationally

"International" means here that the issue is outside the home country of the issuer. A distinction is made between Euro markets and overseas bond markets.

A euro bond is issued by an international banking consortium. The international placement is done in a "major" currency (dollar, euro, yen ).

For foreign bonds is the bond of a domestic currency relative to foreign currency issuer. It is placed from a domestic bank consortium of currency country. The provisions of the interior.

Term

The distinction of bonds to their maturity is purely formal nature, especially because there are many hybrid forms with other financial products (see below). The most common division is:

  • Short notice (up to 4 years)
  • Medium term ( 4-8 years)
  • Long-term ( more than 8 years)

The relationship between (residual) maturity and interest rate of a bond is reflected in the yield curve.

Stripping

When bonds stripping, also known as coupon stripping, the coupon from the securities jacket ( nominal value) is separated, so then the face value and the interest part can be individually treated as zero bond.

Since 1997, the stripping of certain government bonds for a minimum amount of 50,000 euros is possible.

The separation is carried out for the holder of the bond by the respective custodian, the bank or the Federal Securities Administration.

Molding

Income securities come in a very large number of different forms. The financial market has produced in the last two decades a variety of innovative financial instruments, where bonds have played a significant role. Many of these instruments have disappeared from the market, while others stay longer or were added to the standard repertoire of financial institutions.

The main forms, especially for teaching are:

  • Standard Bonds (including fixed rate bonds, straight bonds, plain vanilla bonds) have a fixed interest rate ( coupon) over the entire term ( eg 5% of the nominal value per annum ). They are one of the most common forms of borrowing.
  • (Also called zero coupon bonds) zero coupon bonds have no coupons. The income of the creditor is here solely in the difference between the redemption price and issue price. Therefore, zero coupon bonds are issued usually at a deep discount (ie below par / discount) and at maturity at 100 % ( par) paid back.
  • Redemption bonds ( or even draw bonds) are bonds that have a fixed coupon whose denomination is not repaid as the fixed-interest bonds in full on the due date, but over a certain period. Here, a grace period is generally agreed, after that will be raffled off regularly, which the signers of the bond to get paid back his money.
  • Annuitätenanleihen are bonds in which the repayment in equal amounts carried to the end of the term. These amounts include both the coupon and each part of the settlement.
  • The perpetual, Perpetuities or Konsolbonds
  • Bonds with variable nominal interest rate
  • For step-up bonds, the interest rate changes during the term, the interest rate is fixed staircase already on issue. A distinction is made step-up and step-down bonds, depending on whether the coupon rate over time is rising or falling. For example, federal savings bonds
  • For bonds with step-up coupon, the amount of interest payable often based on the ratings of credit rating agencies, usually at Moody's and Standard & Poor's. If the rating of the bonds downgraded, the interest rate rises, and vice versa. Also, step-up bonds are referred to internationally as " step-up bonds."
  • An inflation-linked bond ( Inflation-Linked Bond) provides protection against the risk of inflation. In typical representatives of this type of bond, the nominal value is adjusted within a predefined period in line with inflation. In most countries, the consumer price index or similar indices will be used.
  • A forced loan ( such as the bonds of the Kingdom of Westphalia ) is a (government ) bond, to be subscribed by law forcibly.

Bonds with option rights

  • When a convertible bond ( convertible ) the creditor has the right to exchange the bond into shares of the issuer, date and number of shares are set out in the issue: technically it is a fixed or variable rate bond, with a call option is associated. In a stock loan (equity bond) the issuer has the right to deliver at maturity instead of the nominal value an agreed upon issue number of shares of the issuer: The coupons in addition to the Interest also a fee for the assumption of risk as the writer of a put option.

Special shapes

  • Convertible bonds: The purchaser is granted the right to convert the bond at a given time in a certain ratio into shares of the issuer.
  • Option Bonds: In contrast to the convertible bond has the right to purchase shares of the issuer is separated from the bond. This means that the option can be traded and exercised separately.
  • Reverse Convertibles are interest distributing derivative products (certificates ) in which the conversion right is the issuer of the bond and usually at the exercise price (strike) of an underlying asset (underlying) is moored. It can be distinguished depending on the underlying in: Convertibles, in which repayment of a stock price depends
  • Index-linked bonds, in which repayment of the price of an index depends
  • Commodity bonds, in which repayment of the price of a commodity index depends
  • Basket- bonds, in which repayment of the price of a basket of different stocks, equity or commodity indices depends. The weightings of the stocks / indices in the basket and the influence of their performances can be designed very differently
  • Other exotic structured products: The Final Redemption Amount and / or interest payments are not agreed, but lock to the status of a certain size (price, stock indices )
  • Hybrid loans, quasi-equity, subordinated corporate bond with no maturity limit.
  • Bunny Bonds: The purchaser is granted the right to choose between the coupon payment coupon or bond the same equipment with a nominal value of EUR. If the coupon rate is lower than the current level of interest rates, you will opt for the payment of the coupons. If the coupon is higher than the current yield level, provides a bond of the same type, which are then listed above par, but can be purchased at face value, a higher return. In this way protects itself against reinvestment risk. The ex post rate of return achieved is higher than the coupon in any case. It will be indifferent if the market for the same interest rate for the remaining term of the bond shall be paid as in the indentures.
  • Bunny Bonds thus have a central position between coupon bond ( reinvestment risk ) and zero bonds (no reinvestment risk ). The reinvestment and interest rate risk move to the issuer.

Special denominations

In the technical language of the stock market a number of asset groups have their own names. Examples are:

  • Samurai Bonds: income securities of foreign issuers in the Japanese capital market in Yen
  • Uridashi Bonds: income securities of foreign issuers in the Japanese capital market in a currency other than yen
  • Yankee Bonds: income securities of non-US issuers in the U.S. capital market in U.S. dollars.

Accrued interest

When buying bonds, the buyer pays the previous owner its rightful share of the coupon. This is called accrued interest or accrued interest.

Example: Investor A has a loan of XY Ltd. with a rate of 6% payable annually in his custody. The next interest payment would be July 1. However, he sold the paper already on June 1, to B. The buyer B has in this case, in addition to the actual market value of the accrued since the last interest payment interest at the rate of 5.5% ( 330 days / 360 days times 6 %) to A to pay. On interest rate futures B then gets paid the full 6 % of the XY AG, although he was only invested one month.

Collateral

Bonds are distinguished by the following collateral:

Government bonds, such as government bonds, on the other hand unsecured bonds. Public budgets are legally incapable of bankruptcy in Germany. In the U.S., however, are communities in insolvency insolvent under the special scheme of Chapter 9 United States Bankruptcy Code. Since the insolvency of Argentina (see also Argentine crisis ), however, a discussion of a bankruptcy law for nation-states takes place. Federal bonds are still safe, as tax revenues and the Treasury (basic, real estate, investments, for example ) is considered a solid source of income; the state can at least theoretically make by changing the tax laws always the means available that are necessary to service the debt.

In practice, however, shows the case of Argentina or the German currency reform that this alone is not sufficient. Likewise, the Soviet Union had refused the legal successor of Tsarist Russia, bonds to use from this time. This led however to the fact that the Soviet Union could not borrow money for a long time. Russia had the Czarist bonds serve the early 1990s, partly in order to borrow money on the capital market with new bonds can.

Stock price and rating

Assessment

With a bond, the investor can generate two types of income:

Most bonds are listed as a percentage of their nominal value. A course of 101.25 means, therefore, that the buyer is to pay 101.25 % of the nominal value of the bond buying has ( plus any accrued interest). However, there are a few exceptions which are denominated in nominal currency (eg French convertible bonds).

The value of a bond shall be the present value of all expected future payments (ie coupon payments and repayment of par value ). This means that the yield on bonds with the same credit rating and remaining maturity regardless of the coupon is always the same, namely market return plus a credit premium.

As a general formula for calculating the value of a bond thus applies at constant interest rate r:

Or

In which

  • P0 = Present value (price ),
  • C = coupon payment,
  • N = amount payable at maturity ( = nominal )
  • N = number of periods,
  • R = each valid interest rate

Critical to note is in the above formula, however, that

Example review

Situation 1

The bond of the X AG had the following features:

  • Duration: 3 years
  • Nominal value: 100 €
  • Coupon: 5 % ( the risk-free market interest rate is also 5%)
  • Emission at par (= 100 %)

A prospective buyer can therefore safely expect the following cash flows over the next three years:

  • In 1 year: € 5 coupon
  • In 2 years: € 5 coupon
  • In 3 years: € 5 coupon 100 € = € 105 repayment

The present value of the paper is therefore:

Situation 2

Shortly after the above interested party for the securities decided the risk-free market interest rate rises to 8%. Investors are of course the fixed payments, but the price (present value ) of its bond changes:

The price of the annuity falls as possible buyers take into account that they get to an alternative form of investment risk-free interest rate in the market rate of 8%. Consequently, it is uneconomical to buy some of the bond to 100 € the investor and to take only a five percent interest in the claim. The only way to buy or sell the securities yet, so there usually is to accept a lower sales price.

The stock prices of exchange-traded bonds also comes the risk of default added as price and coupon determining factor. The risk of default is determined by the expected ability to pay ( credit ) of the bond debtor. The coupon rate of a bond is the date the bonds are higher than the risk-free market interest rate, the lower the credit rating. Deteriorates the creditworthiness of a bond debtor, the rising default risk leads to a greater discount to the loan amount (the higher the discount rate ) and the price drops.

Calculating the yield ( effective interest rate, yield to maturity, yield to maturity )

It is often not interesting to know what the value of a bond on this day, but what return can be achieved by purchasing a bond at a known price today. The return is in general differ from the interest rate in the market and also the coupon of the bond, which will depend on the creditworthiness of the borrower, etc. For the calculation, there is indeed an approximation formula which is rather vague:

With

  • K = Coupon
  • PM = market price
  • N = maturity in years
  • Nominal value assumed to be 100

It is better to use as long as interest rates in the valuation formula for a given bond type, to the calculated value with the purchase price matches ( iteration).

Much easier to use Yield calculator is. These are available on the Internet as part programs, partly as an online calculator for free.

In addition to the more conventional yield to maturity ( effective interest rate ) and the current yield exists (current yield ). Also this is different from the interest rate. Simply calculated as the " interest rate times 100 divided by price ".

The current yield is not a standard of comparison in fixed income trading. However, the current yield is the percentage return on the basis of each course. She is gaining importance in bonds from issuers with a low credit rating and high price deviations from the nominal value.

Another possibility to compare different bonds is the " Doppler effect ". To determine how quickly doubled the value of a bond investment, is sometimes used by investors a rule of thumb: The number 70 is to be divided by the yield to maturity. With a return of seven percent, for example, the capital doubled in 10 years (70: 7 = 10). If the return on the other hand, five percent, it takes 14 years. Prerequisite for the calculation: The interest due will be at constant conditions regularly reinvested ( compounding).

Arbitrage

For bonds anomalies can be arbitrated. For example, an arbitrage strategy is feasible when a coupon bond is rated too low. Then go to this long ( buying ) and sold ( "short selling" ) simultaneously zero bonds in the amount of interest payments. The arbitrage profit is then given (in this example model ) today, with future as a result all positions zero.

Different reviews but can also arise due to credit market frictions and differences.

Risks

Default risk

The default or credit risk is that risk which arises from the fact that the debtor may default in payment or even insolvent. The worse the credit rating, the higher the default risk of the bond. Borrowers with poor credit ratings must therefore offer a higher coupon or a higher interest rate to remain attractive despite the risk of default. That even involve government bonds risks, was last in December 2008 in the case of bonds issued by the Republic of Ecuador, which ceased the payment of interest.

The default risk of bonds can diversify in part, by dividing his money on bonds of different companies. Thus, the failure of a single bond in the portfolio has a less severe loss. However, it can be observed that bond failures can accumulate in a given time interval. It can therefore be significantly more bonds in a given period of time than you would expect at stochastically independent failures.

The creditworthiness of individual companies and bonds sized international, independent agencies from their point of view with a rating. The best-known rating agencies are Moody 's, Standard & Poor's and Fitch. Bonds issued by borrowers with poor credit ratings are also called junk bond, junk bond or high-yield bond.

To reduce the risk for the investor to take over bond insurers that risk in return for payment.

The repayment of a bond may be dispensed even against the will of an individual creditor in whole or in part, provided in the Conditions corresponding Collective Action Clause is deposited, and a majority of creditors consents to such discontinuation.

Interest rate risk

The interest rate risk is the risk that arises from the possibility of a change in market interest rates. While a loan is always repaid at par, but the market interest rate has an influence on the price of the bond, which is important if you sell the bond before maturity again.

The market interest rate is the most important, but at the same time also the most volatile parameter for the evaluation of a bond. A change in the interest rate has the following consequences for the holder of a bond:

  • The value of the bond will fall if the market interest rate increases. This effect is dependent on the price sensitivity, which can be measured by duration and convexity.
  • Repayment amounts (coupon and principal ) are applied to the new interest rate. The interest rate rises, so does the amount resulting from the reinvestment of redemption amounts increases ( compound interest ).
  • The interest income from the coupons of the bond remains unchanged.

The course change and the effect of compound interest are in opposite directions. To answer the question of what overall effect has an interest rate change on the price of a bond, the concept of duration has been developed.

Call risk, draw risk, conversion ( Wandelungs ) risk

These are three types of uncertainties that occur only in certain bonds for which call option or a draw for the repayment has been agreed, or if it is convertible.

Währungs-/Wechselkursrisiko

The nominal currency is the currency in which the bond will be redeemed by the issuer at maturity. The Coupon currency is the currency in which the interest is paid. In almost all bond 's coupon and principal currency are identical.

Due to exchange rate changes in the purchase of a foreign currency bond includes a foreign exchange risk. If the nominal currency against the local currency of the buyer, he suffers losses, the nominal currency appreciates against the local currency, he may realize gains.

The currency risk can be minimized by currency options, currency forwards and currency futures.

Inflation risk

The inflation risk is the uncertainty about the real extent of future payments. Since the Fisher effect is empirically detectable only in the long term, the inflation risk is to be assessed separately from interest rate risk. The inflation risk can be eliminated by the purchase of inflation- indexed bonds.

Liquidity risk

It is possible that at the time at which the bond is to be sold, it can not be done without large price declines. This risk is negligible in markets with high market volume usually; it may be in small markets or with exotic bonds exist. See also: Market liquidity risk

Depreciation risk

It is possible that a bond value decreases, but it keeps the bond and realized no losses. This can happen, for example, due to a rising interest rate. Nevertheless, the bond due to the commercial law needs to be partially written off, which can lead to undesirable reductions in profit in the balance sheet.

Development of the course over time

Since the par value of the bonds will be repaid at maturity, it comes to nominal convergence, bond prices thus move towards the end of the term in the direction of the nominal value. The effect of price changes that result from the passage of time - without changing the yield curve - is called Rolling down the yield curve effect. This effect may be assuming a constant yield curve over time ( this does not mean a flat yield curve) represent the basis of the bond price at any point during the term. In this case, the price will rise only over the issue price and then fall to par again.

Causes rolling down the yield curve effect

Discounting the same payments, that is, of the same coupons, carried out with lower interest rates at a given normal yield curve. This discounting is also a shorter period. This explains a rise in the exchange rate.

The opposite effect, that the coupon of the previous dates will be invisible, dominated at the end of the term. The movement of the price of a bond towards the face value at maturity is called a pull-to - par effect.

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