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Chapter 7
Bond Markets
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Background on bonds

Treasury and federal agency bonds

Municipal bonds

Corporate bonds

Institutional use of bond markets

Globalization of bond markets
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Background on Bonds

Bonds represents long-term debt securities that are
issued by government agencies or corporations

Interest payments occur annually or semiannually

Par value is repaid at maturity

Most bonds have maturities between 10 and 30 years

Bonds

The U.S. Treasury issues Treasury notes
or bonds to finance federal government
expenditures

Note maturities are usually less than 10 years

Bonds maturities are 10 years or more

An active secondary market exists

The 30-year bond was discontinued in
October 2001
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Treasury and Federal Agency
Bonds (cont’d)

Treasury bond auction

Normally held in the middle of each quarter

Financial institutions submit bids for their own accounts
or for clients

Bids can be competitive or noncompetitive

Competitive bids specify a price the bidder is willing to pay
and a dollar amount of securities to be purchased


Bond dealers serve as intermediaries in the secondary
market and also take positions in the bonds

30 primary dealers dominate the trading

Profit from the bid-ask spread

Conduct trading with the Fed during open market operations

Typical daily volume is about $200 billion

Online trading

TreasuryDirect program ()
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Treasury and Federal Agency
Bonds (cont’d)

Treasury bond quotations

Published in financial newspapers

The Wall Street Journal

Barron’s

Investor’s Business Daily

Bond quotations are organized according to their maturity, with
the shortest maturity listed first

Treasury and Federal Agency
Bonds (cont’d)

Inflation-indexed Treasury bonds

In 1996, the Treasury started issuing inflation-indexed
bonds that provide a return tied to the inflation rate

The coupon rate is lower than the rate on regular
Treasuries, but the principal value increases by the
amount of the inflation rate every six months

Inflation-indexed bonds are popular in high-inflation
countries such as Brazil
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Computing the Interest Payment
of an Inflation-Indexed Bond
A 10-year bond has a par value of $1,000 and a
coupon rate of 5 percent. During the first six
months after the bond was issued, the inflation
rate was 1.3 percent. By how much does the
principal of the bond increase? What is the
coupon payment after six months?
65.50$$1,0135%Payment Coupon
013,1$1.013$1,000Principal
=×=
=×=
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Treasury and Federal Agency
Bonds (cont’d)


Revenue bonds are supported by the revenues of the project for
which the bonds were issued

Municipal bonds typically pay interest semiannually, with
minimum denominations of $5,000
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Municipal bonds have a secondary market
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Most municipal bonds contain a call provision
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Municipal Bonds (cont’d)

Credit risk

Less than .5 percent of all municipal bonds
issued since 1940 have defaulted

Moody’s, Standard and Poor’s, and Fitch
Investor Service assign ratings to municipal
bonds

Some municipal bonds are insured against
default

Results in a higher cost for the investor