Bonds

key concepts

• Bonds: contractual loans to corporations and governments
• Coupon payment = coupon rate $\times$ face value
• Types
  • Corporate: higher coupon rate and longer maturity date
    • Riskier
  • Federal government bonds
    • Zero coupon bonds
      • Treasury bills (T-bills): maturity date of 1 year or less
    • Semi-annual coupon payments
      • Treasury notes: 1–10 years
      • Treasury bonds: 10–30 years
    • Interest earned tax free at state level
  • State and local government bonds
    • Tax-exempt interest at federal level
• Default risk: risk that company or government cannot repay bond
• Rating agency: scores entities based on ability to pay debt — AAA, C, and D
• Inflation risk
• Interest needed = base rate + inflation premium + rating premium + other adjustments
  • Base often = interest rate on US-issued debt because thought to be free of default risk

notes

• Appeal
  • Low-risk fixed income
  • Tax incentive for issuing companies
  • Help diversify a portfolio
• Because considered debt, investors paid before shareholders
• If you sell a bond before maturity, you receive fair market value instead of face value
• Inverse relationship between current interest rates and fair market value of bonds