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2 types of bond markets
primary and secondary
primary bond market
buying bond happens once
secondary bond market
buying bond happens multiple times
buying bond
"lending money" to the issuer (ie company/gov)
why are bonds sometimes called DEBT INSTRUMENTS?
bc u are acting as the lender
how is BUYING a bond considered BOTH a loan and a sale?
It's a loan because you expect to be paid back with interest.
It's also a sale because the issuer is selling you a debt security.
BOND
A debt security issued by governments or companies to raise money from multiple investors
LOAN
A direct borrowing agreement between a borrower (individual or business) and a lender (bank or financial institution)
Issuing a bond
(company/gov.) borrowing money from investors
who is issuer in a bond?
person taking the loan and promising to pay interest over time (give out debt security)
are bonds a liquid investment?
YES. can buy/sell very easily
if a bond is from a well-known issuer, how is its liquidity?
very good. bc it has a KNOWN credit risk
Face Value of a Bond
The amount the bondholder will receive back at maturity.
Principle is usually _____________ to the Face Value
equal
Principle in loans
what needs to be repaid, excluding interest
coupon
fixed interest rate
coupon is usually quoted as a _______________________
% of face value
maturity
length of time until the bondholder gets back the face value.
issuer of a bond
entity that issues the bond and borrows money (e.g., government, corporation)
what determines credit risk?
who the ISSUER is
government bonds are ___________ then corporate bonds
safer
corporate bonds have _______________ potential returns then gov. bonds
higher
zero-coupon bonds
no interest payments, but sold at a discount
fair market value
where demand intersects supply
if fair value goes up, the bond is worth more (EXPLAIN THIS)
- If investors want the bond more, its market price increases.
- This can happen if interest rates drop, making existing bonds with higher rates more valuable.
If Coupon Goes Up, the Bond is Worth More to investors (EXPLAIN THIS)
The coupon is the interest the bondholder receives.
A higher coupon means higher regular payments, making the bond more attractive to investors.
Investors will pay a higher price to own bonds with better coupon rates.
issuer vs investor in BONDS
issuer: entity who sells the bond to raise money (ie. gov/company)
investor: entity who buys the bond to make money (via debt securities)
investor receives __________________ and ____________________ at maturity
interest payments (coupon) and face value (principle) at maturity
credit risk
default risk
in the real world, what are we most worried about when it comes to credit risk? why?
bankruptcy
- in the event of bankruptcy, the bond holders dont have to pay it all off (we might get some assets or smth)
usually, we think of gov. bonds as having close to _____ credit risk. (if the loan is in their own currency).
0
why do we think of gov. bonds as having close to 0 credit risk?
being the gov. has so much money, and it can raise taxes to make more money or just print more money
what is the average probability of default for bonds?
5% (we dont get 5% back)
If a bond has 0 credit risk, then it will remain....
close to fair market value
- the loan market value is FAIR (for short-term)
inflation reduces the ________ value of bond payments
real
how does inflation reduce the purchasing power of bond payments?
If inflation rises, bond values decrease because fixed payments become less valuable in real terms.
a bond must offer enough ____________ to compensate for both inflation and credit risk
yield (interest)
a bond must offer enough yield (interest) to compensate for both __________________ and ______________
inflation and credit risk
coupon is APPROXIMATELY equal to ....
YTM (Yield to Maturity) or Fair Market Interest Rate
share of stock
% ownership of the company
stockholders have a claim on ___________________ but no guaranteed return
future profits (cash flow)
2 ways companies raise capital
issue stocks or bonds
companies issue stocks to...
raise equity
companies issue bonds to...
borrow money
can both bonds and stocks be traded in the secondary market?
yes
are bonds or stocks riskier?
stocks
why are stocks riskier then bonds?
stocks depend on mkt conditions, while bonds provide FIXED INTEREST PAYMENTS (except in the event of default)
3 types of assets
real assets, financial assets, financial instruments (securities)
real assets
Physical, tangible assets like factories, machinery, real estate (used for production).
financial assets
Represent claims on cash flows, such as stocks, bonds, and loans.
financial instruments (securities)
Tradable assets like stocks and bonds, which represent ownership or debt.
new securities are issued in the __________ market
primary
2 types of primary markets
IPO (Initial Public Offering) and SEO (Seasoned Equity Offering)
IPO
Initial public offering, a corporation's first offer to sell shares to the public
SEO
Seasoned equity offering, any other sale of stock to public after IPO.
where are existing securities traded between investors?
secondary market
2 examples of secondary market
NYSE (New York Stock Exchange) or NASDAQ
stock exchange
a market for buying and selling stock
2 examples of stock exchange
NYSE, NASDAQ
are stock exchanges a primary or secondary market?
secondary
Index
- measurement of the performance of a specific group of stocks that represent a portion of the market.
S&P 500 and Dow Jones are examples of...
Index
Index is used to....
track and compare the overall performance of stocks, sectors, or the entire economy.
S&P 500
A stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.
Dow Jones Industrial Average (DJIA)
The average price of 30 selected industrial stocks, used as a measure of general market trends
in a bond, who is the issuer?
entity that sells the bond (borrows money)
in a bond, who is the borrower?
the issuer is ALSO the borrower
3 types of stocks
direct ownership (individual stocks), mutual funds, Exchange Traded Funds (ETF)
Direct ownership (individual stocks)
buying shares of a specific company. ex) Tesla, Apple
Mutual funds
Professionally-managed fund pool of money to invest in multiple stocks (think Hetalmama and what he does)
how does a zero-coupon bond work?
instead of recieving interest, investors buy it at a DISCOUNT and recieve the full face value at maturity
give an example of a zero-coupon bond
a bond w a face value of $1000 might be sold for $800 today and redeemed for $1000 at maturity
analysts aim to estimate the ________________ of a company
value
_________________ aim to estimate the value of a company
analysts
the fair interest rate that determines bond prices is called____________
YIELD
Yield in bonds
ROI expected from a bond
what influences whether a bond is sold at par, premium or discount?
yield
with mutually exclusive projects, the project with the ___________ NPV should be taken
highest
How can excessive cost-cutting or excessive price hikes boost short-term profits but harm long-term growth?
For example, a company may cut R&D expenses to show higher earnings this year, but this could hurt innovation and competitiveness in the future.
current cash flow
money a company is generating NOW from operations
future cash flow
money a company may generate in the future from INVESTMENTS, INNOVATION, EXPANSION, and CUSTOMER RETENTION
What is a good strategy when balancing current and future cash flow?
Ensure that the firm doesn't sacrifice future financial health for short-term gains
the stock market values firms based on..
expected future earnings, not just current profits
- investors prefer companies with consistent growth and stability over time, rather then those that just have short bursts of high profit followed by declines
Market Cap
Total market value of a company's outstanding shares.
Arbitrage
The practice of buying and selling equivalent goods to take advantage of a price difference
__________________ is a way to take advantage of temporary mkt inefficiencies
Arbitrage
the price of the same stock/asset can differ between countries due to....
1. Time zones: Different trading hours (e.g., NYSE opens when Taiwan's market is closed).
2. Market efficiency: Information spreads at different speeds.
3. Exchange rates: Currency fluctuations can impact prices.
While both PV and FV give the same value, which formula do we usually use?
PV
Present Value (PV)
market value of a cash flow expected to be received in the future
"discounting to the present" means
taking present values
discount rate
rate of return that could be earned on similar alternative investments
2 other words for discount rate
hurdle rate and OC of Capital
perpetuity
series of payments that continue forever
annuity
series of payments that end on a specific date
PV is today's ____________________ of a cash flow expected to be received in the future
market value
taking present values is also known as...
discounting to the present
discount rate
rate that can be earned on similar alternative arrangements
hurdle rate
minimum acceptable rate of return (a project must generate to be considered worthwhile)
PV of a stream of future cash flows =
sum of the PV of each of the cash flows
valuation
determining the PV of an asset, company or investment
