Unit 3

Bond and Mortgage Markets

• Bond Market is a marketplace where purchasing
and selling of debt securities like bonds takes
place. It is one of the major sources of finance for
both government and corporates. These bonds
carry fixed interest payments and also have a
fixed maturity date. A bond market is a platform
for raising funds from the general public at large.
The government and companies can issue bonds
to the public at large. There are many other
names for this market, like Fixed-Income
Securities Market, Debt Market, and Credit
Market.
 Participants bond markets
• Issuers
• Investors
• Intermediaries
• Regulators
• Issuers: These are the entities that borrow money from
the market by issuing bonds. Issuers can be
governments, corporations, financial institutions, or
other organizations that need to raise funds for various
purposes, such as financing public spending, investing
in projects, or refinancing existing debt. Issuers have to
consider various factors when deciding to issue bonds,
such as the amount, maturity, currency, interest rate,
and credit rating of the bonds, as well as the market
conditions and investor demand. Issuers also have to
comply with the legal and regulatory requirements of
the market where they issue the bonds, and maintain
good communication with the investors and
rating agencies.
• Investors: These are the entities that lend money to the
issuers by buying bonds. Investors can be individuals,
institutional investors, or foreign investors, each with
different risk preferences, return expectations, and
investment horizons. Investors can buy
bonds either in the primary market, where new bonds
are issued, or in the secondary market, where existing
bonds are traded. Investors can also use various
strategies to enhance their returns or hedge their risks,
such as diversifying their portfolio, trading on market
movements, or using derivatives. Investors have to
monitor the performance and
credit quality of the bonds they hold, as well as the
market trends and macroeconomic factors that
affect the bond prices and yields.
• Intermediaries: These are the entities that facilitate the
issuance and trading of bonds in the market.
Intermediaries can be banks, brokers, dealers, or market
makers, each with different functions and
responsibilities. Intermediaries can act as underwriters,
who help the issuers to design, price, and sell the bonds
to the investors, or as market makers, who provide
liquidity and price discovery to the market by quoting
bid and ask prices for the bonds. Intermediaries can also
provide various services to the issuers and investors,
such as advising, research, analysis, clearing, settlement,
custody, or reporting. Intermediaries have to
manage their own risks and costs, as well as comply
with the market rules and regulations.
• Regulators: These are the entities that oversee and
supervise the functioning and stability of the bond
market. Regulators can be central banks, securities
commissions, or other authorities, depending on the
jurisdiction and the type of bond market. Regulators
have various roles and powers, such as setting the
monetary policy and interest rates, issuing licenses and
rules for the market participants, enforcing compliance
and disclosure standards, conducting inspections and
investigations, imposing sanctions and penalties, or
intervening in the market in case of crisis or disruption.
Regulators have to balance the objectives of promoting
market efficiency, transparency, and fairness, while
preserving market stability, integrity, and confidence.
 Concepts of corporate bond
• A debt security that is issued by a company to
raise capital.
• Corporate bonds are debt securities that public
and private companies issue to raise funds and
serve their various business purposes.
Investors who purchase these bonds become
the lending entity for these firms, which pay
them interest on the principal amount and
return the same once the bond matures.
 Bond characteristics
• Par Value
• Coupon interest rate
• Maturity period
• Call provision
• Indenture
• Trustee
• Sinking fund provision
• Convertible
 Bond indenture
A legal document that states the conditions
under which a bond has been issued, the rights
of bondholders and the duties of the issuer.

Protective Covenants
• Restrictive covenants
• Positive covenants
Sinking fund provision
participants of bond market
 Market quotes
• The bond quote represents the value of the bond at the time
of trading, usually in terms of percentage of face value or
yield.
• Reading the bond quotation makes it easy to obtain more
information about the investment instrument than just the
current price. It may, for example, include its bid price, ask
price, yield, maturity, coupon rate, and spread.
• Bond quote provides the current price at which a bond is
traded in the market. It's essential for investors and traders to
gauge the value of a bond in the marketplace. Bond quotes
are typically provided as a percentage of the bond's face
value, the amount the bond will be worth at maturity.
Understanding bond quotes helps investors compare different
bonds and decide which bonds to buy or sell.
Trading procedures of Bond
 Bond rating
• Bond ratings are a system used by investors to compare the
creditworthiness of different bonds. The ratings are assigned by
credit rating agencies, which are companies that collect data on
the financial stability of companies and issue
ratings based on that information. The Major rating agencies are
Moody’s, Standard & poor’s and fitch rating. There are three
main types of ratings: A, B, and C.
• A rating is the highest and indicates the bond is very likely to be
repaid in full. A rating is given to a bond if the agency believes
that it has a high degree of financial stability.
• B ratings are given to bonds if the agency believes that the issuer
will likely be able to meet its repayments, but not if the agency
believes that the issuer will not be able to meet its repayments.
• C ratings are given to bonds if the agency does not have enough
information to give a better rating.
 Comparison of bond market securities
Basis Government bond Corporate bond Municipal Mortgage-
bond Backed
Securities

Issuers National governments Corporations State or local Government,

governments private
institutions.

Risk Low Varies (investment- Low to Moderate to

Level grade bonds are lower moderate high
risk, while high-yield or
junk bonds are higher
risk).

Returns Low Higher than Moderate, Higher than

government bonds, often tax- government
especially for high-yield advantaged. bonds.
bonds

Maturity Short-term (T-bills), Short to long-term. Short to long- Varies

medium-term (T- term.
notes), and long-term
(T-bonds)

Liquidity Highly liquid Varies (investment- Less liquid Less liquid than
 International Aspects of Bond Markets
 Eurobonds
• A Eurobond is a debt instrument that's denominated in a currency
other than the home currency of the country or market in which it is
issued.
• Eurobonds are important because they help organizations raise
capital while having the flexibility to issue them in another currency.
• Eurobond refers only to the fact the bond is issued outside of the
borders of the currency's home country; it doesn't mean the bond
was issued in Europe.

• Foreign Bonds
• Souverain bonds
• Foreign Bonds
A foreign bond is a debt security issued in a
domestic market by a foreign entity in the
domestic market's currency as a means of
raising capital. For foreign firms doing a large
amount of business in the domestic market,
issuing foreign bonds, such as bulldog bonds,
yankee bonds, and samurai bonds, is a common
practice.
• Souverain bonds
A sovereign bond is a specific debt instrument issued
by the government. They can be denominated in both
foreign and domestic currency. Just like other bonds,
these also promise to pay the buyer a certain amount
of interest for a stipulated number of years and repay
the face value on maturity. They also have a rating
associated with them which essentially speaks of their
credit worthiness.
To meet their expenditure, governments have 2
options: either to raise taxes or to issue bonds. Raising
taxes is an unpopular move which has a lengthy legal
process. So, Sovereign bonds are preferred as they are
similar to taking loans from the market.
 Municipal Bond
• A municipal bond refers a bond or fixed income security
that is issued by a government municipality, township, or
state to finance its governmental projects. Municipal
bonds are also referred to as “muni bonds” or “muni.”
• Municipal bonds are a popular fixed-income investment
option for investors seeking a reliable source of income
and tax benefits. The bonds issued by municipalities can
be general obligation bonds, revenue bonds, or special
revenue bonds, and can have varying interest rates and
terms.
• The advantage of municipal bonds for investors is the fact
that they are tax-exempt, meaning that the returns from
such bonds are not subject to taxes. It makes it a highly
attractive investment for individuals who are in a high tax
bracket.
 Types of Municipal Bond
Tax backed debt
• General obligation debt
• Appropriation backed obligation
Revenue bonds
Trading procedures of Municipal Bond
• Primary market
• Secondary market
 Yield on municipal bonds
• The yield on a municipal bond is the return an
investor can expect to receive from holding
the bond until maturity.
• Municipal bonds are unique because their
interest payments are often exempt from
federal income taxes and, in some cases, state
and local taxes. This tax advantage makes their
yield particularly attractive to investors in
higher tax brackets
• Coupon Yield
• Current Yield :The current yield is the annual
interest payment divided by the bond's current
market price.
• Yield to Maturity (YTM)
• Yield to Call (YTC)
• Tax-Equivalent Yield (TEY) : Since municipal bond
interest is often tax-exempt, the tax-equivalent
yield is used to compare munis with taxable bonds
Comparison of municipal bond and full
taxable bond rates
Conversion of municipal bond rate to a tax
equivalent rate
Treasury Notes, Treasury Bonds and STRIPs
Treasury Notes are government securities
which are issued with maturities of 2, 3, 5, 7,
and 10 years. Notes pay interest every six
months. Notes pay a fixed rate of interest
every six months until they mature. You can
hold a note until it matures or sell it before it
matures. A Treasury note is an instrument
carrying a fixed interest rate and duration
issued by the government in the market. This
note is the most preferred option as the
government gives it (hence, no risk of default)
and provides a guaranteed amount as a return,
which helps the investor plan their expenses
accordingly.
It best suits those who are dependent on someone,
such as senior citizens who need regular funds to
live their livelihood. Its maturity ranges between 2
years to 10 years. The interest is fixed, and the yield
may be competitive or non competitive. It is trendy
in the secondary market, which makes it highly
liquid. The interest is half yearly or annually.
Features
• These are for a fixed duration.
• These are riskless securities.
• There is also a regular payment of returns from
the treasury note rates in the form of interest.
• The returns earned are tax-free, i.e., exempt from
tax.
Treasury Bonds
Treasury Bonds (different from
U.S. Savings Bonds) pay interest every six
months. Historically a 30-year investment,
Treasury Bonds are now offered in 20-year
terms, as well.
• Treasury bonds (T-bonds) are fixed-rate U.S. government
debt securities with a maturity of 20 or 30 years.
• T-bonds pay semiannual interest payments until
maturity, at which point the face value of the bond is
paid to the owner.1
• Along with Treasury bills, Treasury notes, and Treasury
Inflation-Protected Securities (TIPS), Treasury bonds are
one of four virtually risk-free government-issued
securities
Treasury bonds, also known as T-bonds, are
a type of fixed-income security issued by
the US government. The bonds have a
maturity period of 10 to 30 years and pay
interest semi-annually until maturity. The
principal amount of the bond is returned to
the investor upon maturity. Treasury bonds
are considered low-risk investments
because they are backed by the full faith
and credit of the US government. In other
words, investors can be confident that the
government will pay back the principal and
interest owed on the bond.
 Separate Trading of Registered Interest and
Principal of Securities (STRIPS)
STRIPS let investors hold and trade the individual
interest and principal components of eligible Treasury
Notes, Bonds, and TIPS separately. STRIPS are popular
with investors who want to receive a known payment
on a specific future date. They are held and sold only
through brokers, dealers, or financial institutions.
STRIPS is a zero coupon bond, issued by the US
Government. STRIPS is a type of Treasury security that
allows investors to buy and sell the individual components of
a bond separately.
When a Treasury bond is "stripped," to become a Strips, its
coupon payments and principal are separated and sold as
individual securities.
trading
market quotations
yields on T-securities
 Determination of clean price and full
price of T- notes on the basis of market
quotation