Reading the Bond Tables in the Wall Street Journal Basic Information And Tutorials

You can find daily updates on the prices and yields for Treasury bills, notes, and bonds and for corporate bonds on the Wall Street Journal Web site or on Yahoo finance (finance.yahoo.com).

Treasury Bonds and Notes
The table below contains data on five U.S. Treasury bonds and notes from the many bonds and notes that were being traded on secondary markets on July 16, 2010. Treasury notes have maturities of 2 years to 10 years from their date of issue; Treasury bonds typically have a maturity of 30 years from their date of issue.

The first two columns tell you the maturity date and the coupon rate. Bond A, for example, has a maturity date of August 15, 2015, and a coupon rate of 4.250%, so it pays $42.50 each year on its $1,000 face value. The next three columns refer to the bond’s price.

All prices are reported per $100 of face value. The numbers following the colon refer to thirty-secondths of a dollar. For Bond A, the first price listed, 112:08, means “112 and 08/32,” or an actual price of $1,122.50 for this $1,000 face value bond.

The bid price is the price you will receive from a government securities dealer if you sell the bond. The asked price is the price you must pay the dealer if you buy the bond. The difference between the asked price and the bid price (known as the bid–asked spread) is the profit margin for dealers.

Bid-asked spreads are low in the government securities markets, indicating low transactions costs and a liquid and competitive market. The “Chg” column tells you by how much the bid price increased or decreased from the preceding trading day.

For Bond A, the bid price rose by 8/32 from the previous day. The final column contains the yield to maturity, calculated using the method we discussed for coupon bonds and the asked price. The Wall Street Journal reports the yield using the asked price because readers are interested in the yield from the perspective of the investor.

So, you can construct three interest rates from the information contained in the table: the yield to maturity just described, the coupon rate, and the current yield (equal to the coupon divided by the price: $42.50/$1,122.50, or 3.79% for Bond A).

Note that the current yield of Bond A is well above the yield to maturity of 1.7066%. This illustrates that the current yield is not a good substitute for the yield to maturity for instruments with a short time to maturity because it ignores the effect of expected capital gains or losses.


Treasury Bills
The table below shows information about U.S. Treasury bill yields. Recall that Treasury bills are discount bonds, unlike Treasury bonds and notes, which are coupon bonds. Accordingly, they are identified by only their maturity date (first column).

In the Treasury bill market, following a very old tradition, yields are quoted as yields on a discount basis (or discount yields), rather than as yields to maturity.* The bid and asked columns of Treasury notes and bonds quote prices, while the bidand asked columns for Treasury bills quote yields.

The bid yield is the discount yield for investors who want to sell the bill to dealers. The asked yield is the discount yield for investors who want to buy the bill from dealers. The dealers’ profit margin is the difference between the asked yield and the bid yield.

In comparing investments in Treasury bills with investments in other bonds, investors find it useful to know the yield to maturity. So, the last column shows the yield to maturity (based on the asked price).

Note that in both previous tables, the yield to maturity rises the further away the maturity date is.

COMMON STOCK CLASSIFICATION BASIC INFORMATION AND TUTORIALS

Common stock represents ownership of a firm. Owners of the common stock of a firm share in the company’s successes and problems. If, like Wal-Mart Stores, Home Depot, Microsoft, or Intel, the company prospers, the investor receives high rates of return and can become wealthy.

In contrast, the investor can lose money if the firm does not do well or even goes bankrupt, as the once formidable K-Mart, Enron, W. T. Grant, and Interstate Department Stores all did. In these instances, the firm is forced to liquidate its assets and pay off all its creditors.

Notably, the firm’s preferred stockholders and common stock owners receive what is left, which is usually little or nothing. Investing in common stock entails all the advantages and disadvantages of ownership and is a relatively risky investment compared with fixed-income securities.

Common Stock Classifications 
When considering an investment in common stock, people tend to divide the vast universe of stocks into categories based on general business lines and by industry within these business lines. The division includes broad classifications for industrial firms, utilities, transportation firms, and financial institutions. Within each of these broad classes are industries.

The most diverse industrial group includes such industries as automobiles, industrial machinery, chemicals, and beverages. Utilities include electrical power companies, gas suppliers, and the water industry. Transportation includes airlines, trucking firms, and railroads. Financial institutions include banks, savings and loans, insurance companies, and investment firms.

An alternative classification scheme might separate domestic (U.S.) and foreign common stocks. We avoid this division because the business line–industry breakdown is more appropriate and useful when constructing a diversified portfolio of global common stock investments.

With a global capital market, the focus of analysis should include all the companies in an industry viewed in a global setting. The point is, it is not relevant whether a major chemical firm is located in the United States or Germany, just as it is not releveant whether a computer firm is located in Michigan or California.

Therefore, when considering the automobile industry, it is necessary to go beyond pure U.S. auto firms like General Motors and Ford and consider auto firms from throughout the world, such as Honda Motors, Porsche, Daimler-Chrysler, Nissan, and Fiat.

CORPORATE BONDS BASIC INFORMATION AND TUTORIALS

WHAT ARE CORPORATE BONDS?


Corporate bonds are fixed-income securities issued by industrial corporations, public utility corporations, or railroads to raise funds to invest in plant, equipment, or working capital. They can be broken down by issuer, in terms of credit quality (measured by the ratings assigned by an agency on the basis of probability of default), in terms of maturity (short term, intermediate term, or long term), or based on some component of the indenture (sinking fund or call feature).

All bonds include an indenture, which is the legal agreement that lists the obligations of the issuer to the bondholder, including the payment schedule and features such as call provisions and sinking funds. Call provisions specify when a firm can issue a call for the bonds prior to their maturity, at which time current bondholders must submit the bonds to the issuing firm, which redeems them (that is, pays back the principal and a small premium). A sinking fund provision specifies payments the issuer must make to redeem a given percentage of the outstanding issue prior to maturity.

Corporate bonds fall into various categories based on their contractual promises to investors. They will be discussed in order of their seniority. Secured bonds are the most senior bonds in a firm’s capital structure and have the lowest risk of distress or default. They include various secured issues that differ based on the assets that are pledged.

Mortgage bonds are backed by liens on specific assets, such as land and buildings. In the case of bankruptcy, the proceeds from the sale of these assets are used to pay off the mortgage bondholders. Collateral trust bonds are a form of mortgage bond except that the assets backing the bonds are financial assets, such as stocks, notes, and other high-quality bonds.

Finally, equipment trust certificates are mortgage bonds that are secured by specific pieces of transportation equipment, such as locomotives and boxcars for a railroad and airplanes for an airline.

Debentures are promises to pay interest and principal, but they pledge no specific assets (referred to as collateral) in case the firm does not fulfill its promise. This means that the bondholder depends on the success of the borrower to make the promised payment.

Debenture owners usually have first call on the firm’s earnings and any assets that are not already pledged by the firm as backing for senior secured bonds. If the issuer does not make an interest payment, the debenture owners can declare the firm bankrupt and claim any unpledged assets to pay off the bonds.

Subordinated bonds are similar to debentures, but, in the case of default, subordinated bondholders have claim to the assets of the firm only after the firm has satisfied the claims of all senior secured and debenture bondholders. That is, the claims of subordinated bondholders are secondary to those of other bondholders.

Within this general category of subordinated issues, you can find senior subordinated, subordinated, and junior subordinated bonds. Junior subordinated bonds have the weakest claim of all bondholders.

Income bonds stipulate interest payment schedules, but the interest is due and payable only if the issuers earn the income to make the payment by stipulated dates. If the company does not earn the required amount, it does not have to make the interest payment and it cannot be declared bankrupt.

Instead, the interest payment is considered in arrears and, if subsequently earned, it must be paid off. Because the issuing firm is not legally bound to make its interest payments except when the firm earns it, an income bond is not considered as safe as a debenture or a mortgage bond, so income bonds offer higher returns to compensate investors for the added risk.

There are a limited number of corporate income bonds. In contrast, income bonds are fairly popular with municipalities because municipal revenue bonds are basically income bonds.

Convertible bonds have the interest and principal characteristics of other bonds, with the added feature that the bondholder has the option to turn them back to the firm in exchange for its common stock. For example, a firm could issue a $1,000 face-value bond and stipulate that owners of the bond could turn the bond in to the issuing corporation and convert it into 40 shares of the firm’s common stock.

These bonds appeal to investors because they combine the features of a fixed-income security with the option of conversion into the common stock of the firm, should the firm prosper.

Because of their desirable conversion option, convertible bonds generally pay lower interest rates than nonconvertible debentures of comparable risk. The difference in the required interest rate increases with the growth potential of the company because this increases the value of the option to convert the bonds into common stock. These bonds are almost always subordinated to the nonconvertible debt of the firm, so they are considered to have higher credit risk and receive a lower credit rating from the rating firms.


An alternative to convertible bonds is a debenture with warrants attached. The warrant is an option that allows the bondholder to purchase the firm’s common stock from the firm at a specified price for a given time period.

The specified purchase price for the stock set in the warrant is typically above the price of the stock at the time the firm issues the bond but below the expected future stock price. The warrant makes the debenture more desirable, which lowers its required yield. The warrant also provides the firm with future common stock capital when the holder exercises the warrant and buys the stock from the firm.

Unlike the typical bond that pays interest every six months and its face value at maturity, a zero coupon bond promises no interest payments during the life of the bond but only the payment of the principal at maturity.

Therefore, the purchase price of the bond is the present value of the principal payment at the required rate of return. For example, the price of a zero coupon bond that promises to pay $10,000 in five years with a required rate of return of 8 percent is $6,756. To find this, assuming semiannual compounding (which is the norm), use the present value factor for 10 periods at 4 percent, which is 0.6756.

US TREASURY AND GOVERNMENT AGENCY SECURITIES BASIC INFORMATION AND TUTORIALS

WHAT ARE US TREASURY AND GOVERNMENT AGENCY SECURITIES - FINANCIAL MANAGEMENT

U.S. Treasury Securities
All government securities issued by the U.S. Treasury are fixedincome instruments. They may be bills, notes, or bonds depending on their times to maturity.

Specifically, bills mature in one year or less, notes in over one to 10 years, and bonds in more than 10 years from time of issue. U.S. government obligations are essentially free of credit risk because there is little chance of default and they are highly liquid.

U.S. Government Agency Securities
Agency securities are sold by various agencies of the government to support specific programs, but they are not direct obligations of the Treasury.

Examples of agencies that issue these bonds include the Federal National Mortgage Association (FNMA or Fannie Mae), which sells bonds and uses the proceeds to purchase mortgages from insurance companies or savings and loans; and the Federal Home Loan Bank (FHLB), which sells bonds and loans the money to its 12 banks, which in turn provide credit to savings and loans and other mortgage-granting institutions.

Other agencies are the Government National Mortgage Association (GNMA or Ginnie Mae), Banks for Cooperatives, Federal Land Banks (FLBs), and the Federal Housing Administration (FHA).

Although the securities issued by federal agencies are not direct obligations of the government, they are virtually default-free because it is inconceivable that the government would allow them to default.

Also, they are fairly liquid. Because they are not officially guaranteed by the Treasury, they are not considered riskless. Also, because they are not as liquid as Treasury bonds, they typically provide slightly higher returns than Treasury issues.

FINANCIAL ASSETS CATEGORIES BASIC AND TUTORIALS

WHAT ARE THE CATEGORIES OF FINANCIAL ASSETS?


The following are five key categories of assets:
1. Money
2. Stocks
3. Bonds
4. Foreign exchange
5. Securitized loans

We now briefly discuss these five key assets.

Money
Although we typically think of “money” as coins and paper currency, even the narrowest government definition of money includes funds in checking accounts. In fact, economists have a very general definition of money: Money is anything that people are willing to accept in payment for goods and services or to pay off debts.

The money supply is the total quantity of money in the economy. money plays an important role in the economy, and there is some debate concerning the best way to measure it.


Stocks
Stocks, also called equities, are financial securities that represent partial ownership of a corporation.When you buy a share of Microsoft stock, you become a Microsoft shareholder, and you own part of Microsoft, although only a tiny part because Microsoft has issued millions of shares of stock.

When Microsoft sells additional stock, it is doing the same thing that the owner of a small firm does when she takes on a partner: increasing the funds available to the firm, its financial capital, in exchange for increasing the number of the firm’s owners.

As an owner of a share of stock in a corporation, you have a legal claim to a share of the corporation’s assets and to a share of its profits, if there are any. Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends, which are payments corporations typically make every quarter.

Bonds
When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. The interest rate is the cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed. For instance, if you borrow $1,000 from a friend and pay him back $1,100 a year later, the interest rate on the loan was $100/$1,000 = 0.10, or 10%.

Bonds typically pay interest in fixed dollar amounts called coupons. When a bond matures, the seller of the bond repays the principal. For example, if you buy a $1,000 bond issued by IBM that has a coupon of $65 per year and a maturity of 30 years, IBM will pay you $65 per year for the next 30 years, at the end of which IBM will pay you the $1,000 principal.

A bond that matures in one year or less is a short-term bond. A bond that matures in more than one year is a long-term bond. Bonds can be bought and sold in financial markets, so, like stocks, bonds are securities.

Foreign Exchange 
Many goods and services purchased in a country are produced outside that country. Similarly, many investors buy financial assets issued by foreign governments and firms. To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency.

For example, consumer electronics giant Best Buy exchanges U.S. dollars for Japanese yen when importing Sony televisions. Foreign exchange refers to units of foreign currency. The most important buyers and sellers of foreign exchange are large banks.

Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets. Banks also engage in foreign currency transactions on behalf of firms that want to import or export goods and services or to invest in physical assets, such as factories, in foreign countries.

Securitized Loans 
If you lack the money to pay the full price of a car or house in cash, you can apply for a loan at a bank. Similarly, if a developer wants to build a new office building or shopping mall, the developer can also take out a loan with a bank.

Until about 30 years ago, banks made loans with the intention of making profits by collecting interest payments on a loan until the loan was paid off. It wasn’t possible to sell most loans in financial markets, so loans were financial assets but not securities.

The federal government and some financial firms created markets for many types of loans. Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization.

To take one example, a bank might grant a mortgage, which is a loan a borrower uses to buy a home, and sell it to a government-sponsored enterprise or a financial firm that will bundle the mortgage together with similar mortgages granted by other banks.

This bundle of mortgages will form the basis of a new security called a mortgage-backed security that will function like a bond. Just as an investor can buy a bond from IBM, the investor can buy a mortgage-backed security from the government agency or financial firm.

The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security.

The bank will receive fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders.

Note that what a saver views as a financial asset a borrower views as a financial liability. A financial liability is a financial claim owed by a person or a firm. For example, if you take out a car loan from a bank, the loan is an asset from the viewpoint of the bank because it represents a promise by you to make a certain payment to the bank every month until the loan is paid off. But the loan is a liability to you, the borrower, because you owe the bank the payments specified in the loan.