what are bonds and notes?

Discussion in 'Trading' started by Gordon Gekko, Aug 6, 2003.

  1. i don't care if people laugh at my newbness. not too long ago i started a thread asking what e-minis are and now i know.

    well now i don't totally understand what bonds and notes are. of course i've heard of them, but i couldn't explain to someone what they really are.

    let's be honest, you don't even really NEED to know what they are to trade them. but i'd still like to have a basic understanding of what bonds and notes are.

  2. also...

    everyone has heard that when stocks go down, bonds go up, etc. is this relationship true?

    how do notes move? like, if notes go up, what should go down, if anything?

  3. def

    def Sponsor

    take a look at investorwords.com, here's a good definition on bonds. a note is less than one year. FWIW simple searches on the web can provide a wealth of information. Now if you are really interested in bonds, then there are number of good technical books available on pricing/trading which you might want to read.

    A debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing. The Federal government, states, cities, corporations, and many other types of institutions sell bonds. Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified date (maturity). Some bonds do not pay interest, but all bonds require a repayment of principal. When an investor buys a bond, he/she becomes a creditor of the issuer. However, the buyer does not gain any kind of ownership rights to the issuer, unlike in the case of equities. On the hand, a bond holder has a greater claim on an issuer's income than a shareholder in the case of financial distress (this is true for all creditors). Bonds are often divided into different categories based on tax status, credit quality, issuer type, maturity and secured/unsecured (and there are several other ways to classify bonds as well). U.S. Treasury bonds are generally considered the safest unsecured bonds, since the possibility of the Treasury defaulting on payments is almost zero. The yield from a bond is made up of three components: coupon interest, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains). A bond might be sold at above or below par (the amount paid out at maturity), but the market price will approach par value as the bond approaches maturity. A riskier bond has to provide a higher payout to compensate for that additional risk. Some bonds are tax-exempt, and these are typically issued by municipal, county or state governments, whose interest payments are not subject to federal income tax, and sometimes also state or local income tax.
  4. i use esignal for quotes. if i want to get quotes of bonds and notes, which subscription on the list below do i need? thx

    CME (U.S.)
    CME E-Minis (U.S.) <-- i already have this
    CBOT (U.S.)
    CBOT Mini-Sized Futures (U.S.)
    NYBOT (U.S.)
    COMEX (U.S.)
    NYMEX (U.S.)
    KCBOT/MGE (U.S.)
    marketprofile (U.S.)
    OneChicago (U.S.) (Single Stock Futures)
  5. msfe


  6. Bond Basics: What are Bonds?

    Just like people need money, so do companies and governments. A company needs funds to expand into new markets while governments need money for everything from infrastructure to social programs. The problem large organizations run into is that they typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands of investors then each lend a portion of the capital needed.

    Really, a bond is nothing more than a loan of which you are the lender. The organization that sells a bond is known as the issuer. You can think of it as an IOU given by a borrower (the issuer) to a lender (the investor).

    Of course, nobody would loan their hard-earned money for nothing. The issuer of a bond must pay the investor something extra for the privilege of using his or her money. This "extra" comes in the form of interest payments, which are made at a predetermined rate and schedule. The interest rate is often referred to as the coupon. The date on which the issuer has to repay the amount borrowed, known as face value, is called the maturity date. Bonds are known as fixed-income securities because you know the exact amount of cash you'll get back, provided you hold the security until maturity.
  7. Bond Basics: Characteristics

    There are a number of characteristics of a bond that you need to be aware of. All of these factors play a role in determining the value of a bond and the extent to which it fits in your portfolio.

    Face Value/Par Value
    The face value (also known as the par value or principal) is the amount of money a holder will receive back once a bond matures. A newly issued bond usually sells at the par value. Corporate bonds normally have a par value of $1,000, but this amount can be much greater for government bonds.

    What confuses many is that the par value is NOT the price of the bond. A bond's price fluctuates throughout its life in response to a number of variables (more on this later). When a bond's price trades above the face value it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount.

    Coupon (The Interest Rate)
    The coupon is the amount the bondholder will receive as interest payments. It's called a "coupon" because sometimes there are physical coupons on the bond that you tear off and redeem for interest. This, however, was more common in the past. Nowadays records are more likely to be kept electronically.

    As previously mentioned, most bonds pay interest every six months, but it's possible for them to pay monthly, quarterly, or annually. The coupon is expressed as a percentage of the par value. If a bond pays a coupon of 10% and its par value is $1,000, then it'll pay $100 of interest a year. A rate that stays as a fixed percentage of the par value like this is a fixed-rate bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In this case the interest rate is tied to market rates through an index such as the rate on Treasury bills.

    You might think investors will pay more for a high coupon than for a low coupon. All things being equal, a lower coupon means that the price of the bond will fluctuate more.

    The maturity date is the future day on which the investor's principal will be repaid. Maturities can range from as little as one day to as long as 30 years (though terms of 100 years have been issued!).

    A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years. Therefore, in general, the longer the time to maturity, the higher the interest rate. Also, all things being equal, a longer term bond will fluctuate more than a shorter term bond.

    The issuer is an extremely important factor as their stability is your main assurance of getting paid back. For example, the U.S. Government is far more secure than any corporation. Their default risk--the chance of the debt not being paid back--is extremely small, so small that the U.S. government securities are known as risk free assets. The reason behind this is that a government will always be able to bring in future revenue through taxation. A company on the other hand must continue to make profits, which is far from guaranteed. This means the corporations must offer a higher yield in order to entice investors--this is the risk/return tradeoff in action.

    The bond rating system helps investors distinguish a company's credit risk. Think of a bond rating as the report card for a company's credit rating. Blue-chip firms, which are safer investments, have a high rating while risky companies have a low rating. Notice that if the company falls below a certain credit rating, its grade changes from investment quality to junk status. Junk bonds are aptly named: they are the debt of companies in some sort of financial difficulty. Because they are so risky they have to offer much higher yields than any other debt. This brings up an important point: not all bonds are inherently safer than stocks. Certain types of bonds can be just as risky, if not more risky, than stocks.
  8. Bond Basics: Yield, Price, and Other Confusion

    The price fluctuation of bonds is probably the most confusing part of this lesson. In fact, many new investors are surprised to learn that a bond's price, just like that of any other publicly-traded security, changes on a daily basis! Here's the thing: so far we've talked about bonds as if everybody held them to maturity. It's true that if you do this, you're guaranteed to get your principal back; however, a bond does not have to be held to maturity. At any time a bond can be sold in the open market, where the price can fluctuate, sometimes dramatically. We'll get to how price changes in a bit. First we need to introduce the concept of yield.

    Measuring Return With Yield
    Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated by the following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield.

    Let's demonstrate this with an example. If you buy a bond at its $1000 par value with a 10% coupon the yield is 10% ($100/$1000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely if the bond goes up in price to $1200 the yield shrinks to 8.33% ($100/$1200).

    Yield to Maturity
    Of course, in real life things always have to be more complicated. When bond investors refer to yield, they are usually referring to yield to maturity (YTM). YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium).

    Knowing how to calculate YTM isn't important right now. In fact the calculation is rather sophisticated and beyond the scope of this tutorial. The key point about YTM is that it's more accurate and enables you to compare bonds with different maturities and coupons.

    Putting It All Together: The Link Between Price and Yield
    The yield's relationship with price can be summarized as follows: when price goes up, yield goes down and vice versa. Technically you'd say the bond's prices and its yield are inversely related.

    Here's a main point of confusion. How can high yields and high prices both be good when they can't happen at the same time? The answer depends on your point of view. If you are a bond buyer you want high yields. A buyer wants to pay $800 for the $1000 bond, which gives the bond a yield of 12.5%. On the other hand, if you already own a bond you've locked in your interest rate, so you hope the price of the bond goes up. This way you can cash out by selling your bond in the future.

    Price in the Market
    So far we've discussed the factors of face value, coupon, maturity, the issuer, as well as yield. All of these bond characteristics play a role in a bond's price. However, the factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with the newer bonds being issued with a higher coupon. And, when interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with the newer bonds being issued with a lower coupon.
  9. Bond Basics: Types of Bonds

    Government Bonds
    In general, fixed income securities are classified according to the length of time before maturity. These are the three main categories:

    Bills - debt securities maturing in less than one year.
    Notes - debt securities maturing in one to ten years.
    Bonds - debt securities maturing in more than ten years.

    Marketable securities from the U.S. Government--known collectively as Treasuries--follow this guideline and are issued as Treasury bonds, Treasury notes, and Treasury bills (T-bills). Technically speaking, T-bills aren't bonds because of their short maturity.

    All debt issued by Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many developing countries, however, does carry substantial risk. Just like companies, countries can default on payments.

    Municipal Bonds
    Municipal bonds are the next progression in terms of risk. Cities don't go bankrupt that often, but it can happen. The major advantage to "munis" is that the returns are free from federal tax. Local governments also sometimes make its debt non-taxable for residents, making some municipal bonds completely tax free. Because of the tax savings the yield is usually lower than that of a taxable bond. Depending on your personal situation munis can be a great investment on an after-tax basis.

    Corporate Bonds
    A company can issue bonds just like it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally a short-term corporate bond is less than five years; intermediate is five to twelve years, and long term is over twelve years.

    Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company's credit quality is very important: the higher the quality, the lower the interest rate the investor receives.

    Other variations are convertible bonds, which the holder can convert into stock, and callable bonds, which allow the company to redeem an issue prior to maturity.

    Zero Coupon Bonds
    This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, a zero coupon bond with a $1000 par value and ten years to maturity might be trading at $600. So today you pay $600 for a bond that will be worth $1000 in ten years.
    #10     Aug 7, 2003