Discussion/Responses

Bond Pricing

All bonds have some common characteristics, but they do not always have the same contractual features. Differences in contractual provisions, and in the underlying strength of the companies backing the bonds, lead to major differences in bonds risks, prices, and expected returns. It is important to understand how bond markets actually function and what the appropriate terminology is.

Choose any two questions to answer:

a. What are some of the factors you should consider when buying a bond?

b. How are Treasury bonds bought?

d. What factors determine a bond’s market price?

e. What role do transaction costs play in bond transactions?

f. What is meant by buying bonds indirectly?

g. How can you find the current price of a bond?

You may want to visit BondsOnline (http://www.bondsonline.com/) to answer these questions.

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Respond #1

Jodi Demay

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DeMay - Post 1

Jodi Demay posted Jun 14, 2019 8:15 AM

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How can you find the current price of a bond?

There are multiple steps in determining how much a bond costs and mainly these steps include calculations of interest rate and present bond price then figuring out the bond price with interest added. According to AccountingTools.com it is the relationship between 2 things the interest rate the bond pays out and market interest rate paid at the same time. When investors bid on bonds they bid down to get the bond price lowered and this is to achieve a good interest rate on the bond itself (Bragg, 2019). 

There are 4 steps to figure out bond pricing:

1. First we need to figure out the interest paid by the bond 2. Find the PV or Present Value of the bond itself 3. Using the PV and interest rate we then figure out the PV of the interest rate 4. Lastly we calculate the bond price using these variables. 

How are Treasury bonds bought?

To purchase treasury bonds you would need to know when treasury bonds are being auctioned. This normally occurs once a month and treasury bonds have a maturity rate of 10 years meaning the bond wont mature for 10 years. There are 3 main ways to purchase a T Bond or treasury bond. You can either go directly through the US Treasury department, through a bank or a broker. Pricing of treasury bonds are determined the day of the auction so esstentially you could be paying higher, lower or at range for the bond itself. To place a bid on a T Bond you would need to create an account through a system called TreasuryDirect.gov as an indivdual you could create a non competitive bid through this website but for competitive bids you would need to then use a bank or a broker to place the bid for you. Banks and brokers use a system called TAAPS to bid on bonds for their clients. 

References:

Bragg, S. (2019, April 02). How to calculate the issue price of a bond. Retrieved June 14, 2019, from https://www.accountingtools.com/articles/how-to-calculate-the-issue-price-of-a-bond.html

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James Bookout

yesterday at 9:55 AM

Hi Jodi:

I think I asked this question in another post.  What is the difference in "finding" and "calculating"?  

For Treasury bonds, good information, what is TAAPS?  Also, why pay a broker to buy treasury securities when you can do it via the website?

thanks

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Jodi Demay

yesterday at 11:06 AM

TAAPS is the Treasury Automated Auction Processing System, it is used by brokers and banks to bid on T Bonds. To find T Bonds versus calculate T Bonds you would need to use the system TreasuryDirect.gov. At that time bidders can look at bonds available and figure out the calculations on which is going to be a better fit for their needs. 

Respond #2

Jamie-Lyn Truax

"It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off

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Jamie-Lyn Truax posted Jun 13, 2019 11:13 PM

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a. What are some of the factors you should consider when buying a bond?

When considering buying a bond it’s important to know what exactly a bond is. A bond is a contract between the purchaser (you) and the issuer (the bond). In this contract the issuer will pay the purchaser all “proceeds” or earnings that the bond generates during its maturity. By purchasing a bond you are taking “future” money over “present” money, as in you will be investing in the ability of the bond to reach maturity.  Since you are taking “future” money there are factors to consider offering yourself some protection against risky investing. You don’t want to purchase a bond that has a probability of not reaching maturity. Many bonds though are fairly safe investments but they may not pay a lot in their maturity but they are more stable than compared actual stocks.

 However, some of the factors you need to consider when investing in bonds is how are you buying the bond? Will you purchase the bond at Par-Value, or face value, discount or below face value, or at a premium which is above face value? These purchase price points can determine how much a bond can earn you at the end of their maturity. Speaking of maturity, when a bond reaches its maturity is a major factor when investing. The maturity date is when the bond is available to cash in, “The maturity date defines the lifespan of a security, informing you when you will get your principal back and for how long you will receive interest payments. “ (Chen, 2018) This is an important date as this will determine if the bond you are purchasing can work with your invest plan. You don’t want to purchase a bond that will mature in 20 years but you are retiring in 10 and are depending on that investment.

If you happen to purchase a bond that is maturing at a time that does not work for your investment plan there are Call Provisions. These provisions allow a purchaser to sell the bond back to the issuer prior to the maturity date. Another factor to consider when purchasing bonds and is a small fail safe against dropping interest rates. If the bond issuer is not the most well rated organization than any call provision may only be available at a discount. Ratings may be the most important factor when investing in bonds. “Bond credit rating agencies assess and report the credit worthiness of a corporation's or government's debt issues.” (FINC 331 Commentary, n.d.)When investing you want some assurances that your investment will provide a payout. These ratings help determine whether or not the organization has creditability to do so.

                My only real experience with bonds is a scene from the The Wedding Singer. The main character is introduced to the antagonist who is a trader in “junk bonds”. The protagonist states that his grandmother purchased him some bonds when he was young and he would get $25 in 1992, the movie was set in 1985.

Chen, J.  (2018) Maturity Date. Investopedia.com. Retrieved from.

https://www.investopedia.com/terms/m/maturitydate.asp

 

[FINC 331 Commentary] (n.d.) Bond Valuation.Boundless. Retrieved from.

https://learn.umuc.edu/d2l/le/content/384552/viewContent/15212429/View

               

 

 

d. What factors determine a bond’s market price?

                Bonds are subject to the same fluctuations as any stock in the market. Incidentally the same factors to consider when purchasing a bond are the same factors that influence a bond price. “…bond prices fluctuate on the open market in response to supply and demand for the bond. “ (Ross, 2018) Specifically, when the bonds are purchased they can be purchased at par, discount, or premium. As in the case when you are considering bonds as an investment, understanding how they are being priced is important to investing. The maturity date will also affect the price of the bond, as will the call provision that maybe tied to the bond. If the bond comes from a reputable organization with a high rating, good maturity with the ability to earn more, and has good call provision that will allow the purchaser to gain their money back should interest rates fall the price will be high. The same could be said of the inverse, if the organization has a low rating, the maturity date is too short or long, and there are no call provisions, the bond will be cheap.

Ross, S. (2018) What determines bond prices on the open market?. Investopedia.com. Retrieved from.

https://www.investopedia.com/ask/answers/112614/what-determines-price-bond-open-market.asp

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James Bookout

yesterday at 10:06 AM

Hi Jamie-Lyn:

Thanks for the comprehensive information.  So, for factors that determine a bond's market price you considered maturity date, call provision (note the call provision allows the "issuer" to call the bond after the call date, rather than the purchaser gaining their money back.  The purchaser doesn't want the bond to be called, typically, and maturity dte.  What about transaction costs?  Risk?

thanks

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