The
Bond Market
"Almost every corporation and government in
the world issues bonds. The bond market dwarfs the stock market,
when measured in dollar volume. In addition,
while stocks are issued solely in the
private sector, both corporations and governments can issue bonds.
For governments, issuing bonds or other similar securities is the
only way they can borrow money.
"In spite of this, the stock market enjoys much
greater public visibility. Day and night, television
news reports on how the
major stock market induces did during the day
fill the airwaves, with some news broadcasts dedicated solely to
reporting on the stock market. Only relatively
recently have news reports also covered the bond market, and then
usually only the market performance of the longest United States
Treasury bond."
"Recent stock market
volatility, and a decline in many stocks, especially technology
stocks, has caused many stock investors to look for other investment
vehicles, either as alternatives to stocks, or simply for balance
and diversification. Many are discovering the diverse world of
bonds. However, because of the attention historically paid to stock
investing, many investors do not understand enough about bonds and
bond markets."
[Source: How the Bond Market Works. By
Robert Zipf. 3rd ed. New York: New York Institute of Finance, c2002.
p xiii. HG4651 .H68
2002 (Library West).
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Warren Buffet on Interest
Rates
"At all times, in all markets, in all parts
of the world, the tiniest change in rates changes the value of
every financial asset. You see that clearly with the fluctuating
prices of bonds. But the rule applies as well to farmland, oil
reserves, stocks, and every other financial asset. And the effects
can be huge on values. If interest rates are, say, 13%, the
present value of a dollar that you're going to receive in the
future from an investment is not nearly as high as the present
value of a dollar if rates are 4%."
[Source: "Warren
Buffet on the Stock Market." By Carol Loomis.
Investor's Guide 2001. Fortune December 10, 2001, p. 80. In
ABI/INFORMM.]
Bonds Market Commentary
"Warren Buffet, or perhaps his sidekick
Charlie Munger, is fond of saying that if you look around the poker
table and you can't identify the fish, then you be the fish.
Managers using corporate tilts may have thought they were the
skippers of their own ocean-faring tuna boats, but as it turns out,
they had gills and are now sucking for oxygen in a local trout farm
located in a city near you. They be the fish."
[Source: "Investment Outlook," By Bill
Gross. August 2002. PIMCO Bonds.]
The
International Desk
"Trading international bond markets can be an exciting and
exhausting enterprise. Markets are traded virtually around the clock
and a portfolio manager must keep abreast of economic, political,
and market factors across 20 to 30 countries to effectively compete
with other global bond managers. Issuers of debt have also become
truly global with most large borrowers generally indifferent whether
they raise funds in U.S. dollars, German marks, Japanese yen, or
Italian lira. Barriers to foreign investment have been reduced as
countries have taken steps to make their markets more liquid and
transparent in order to attract global institutional investors. The
drive for diversification and the search for additional expected
returns have fueled interest in cross-border investing with fixed
income portfolio managers now willing to invest capital in a variety
of countries, including some that did not exist a decade ago. Some
innovations, such as the development of the asset-backed debt
market, have spread from the United States to other countries, and
others, such as the issuance of inflation-indexed bonds, have been
adopted by the United States."
[Source:
"Trading International Bond Markets." By Christopher B.
Steward. In Perspectives on International Fixed income Investing.
Edited by Frank J. Fabozzi. New hope, Pennsylvania: Frank J. Fabozzi
Associates, c1998. HG4651 .P47x 1998 (Library West).
World Bond Market Analysis
--April 30, 2001
Karim Basta
Senior Global Debt Strategist
Merrill Lynch
- "The size of the world bond market last
year totaled $31.4 trillion, close to 100% of the world's gross
domestic product (GDP).
- For the second straight year, Japan had the
world's largest government market (defined as local currency
sovereign debt).
- In the U.S., mortgages eclipsed treasuries as
the second largest market sector, with Corporates as the largest
market sector.
- International bonds, defined as debt placed by
non-resident issuers plus debt issued in the London Eurobond
market, continue to increase their share of the world bond
market. That share now stands at over 20%, compared to only 10%
a decade ago.
- The government sector share of the world bond
market continued its five-year decline. Government bonds now
comprise only 54.7% of the world total and grew by only 0.5%
last year in U.S. dollar terms.
- Our emerging markets tradable debt universe
(both local currency and hard currency issuance) expanded by a
healthy 8.5% last year to reach $1.62 trillion.
- Brady debt as a percent of total emerging
market debt continues to decline. It is now down to 30% from
100% a decade ago.
- The size of the U.S. high-yield market was $517
billion at the end of 2000, though last year's modest increase
was the smallest in market size since 1994.
- Our new global broad market index captures over
45% of the total size of the world bond market. Last year, our
investment-grade index exceeded our high-grade sovereign index
for the first time."
[Source: "World
Bond Market Analysis." By Karim Basta. Merrill Lynch April
30, 2001.]
Risks of
Fixed Income Securities
"The return obtained from a fixed income security from the
day it is purchased to the day it is sold can be divided into two parts:
(1) the market value of the security when it is eventually sold and (2)
the cash flows received from the security over the time period that it is
held, plus any additional income from reinvestment of the cash flow.
Several environmental factors affect one or both of these two parts. We
can define the risk in any security as a measure of the impact of these
market factors on the return characteristics of the security.
"The different types of risk that an
investor in fixed income securities is exposed to are as follows:
- Market, or interest-rate, risk
- Reinvestment risk
- Timing, or call, risk
- Credit, or default, risk
- Yield-curve, or maturity, risk
- Inflation, or purchasing power,
risk
- Liquidity risk
- Exchange rate, or currency, risk
- Volatility risk
- Political, or legal, risk
- Event risk
- Sector Risk
"Each risk is described in this
chapter. They will become more clear as the securities are described
in more detail in other chapters of this book."
[Source: "Risks Associated with
Investing in Fixed Income Securities." By Ravi F. Dattatreya and Frank
J. Fabozzi. Chapter 2, pp. 21-22. In
The Handbook of Fixed Income Securities, 6th ed. New York:
McGraw-Hill, c2001. HG4651 .H265 2000
(Library West & Business Reference & netLibrary:
http://www.netLibrary.com/urlapi.asp?action=summary&v=1&bookid=52366)]
Bonds vs. Bond Funds
"BONDS ARE COMPLEX -- there's no doubt about
it -- especially if you're a novice investor with little experience
in the markets. That's why a lot of people opt for bond funds when
they seek to diversify their investments with some fixed-income
exposure. Our view is that if you're willing to put in the effort,
you're better off buying individual bonds instead of bond funds. But
in the real world, a fund is sometimes worth the convenience.
Here's what you have to consider:
Like an equity mutual fund, a bond fund is managed
by a professional investor who buys a portfolio of securities and
makes all the decisions. Most funds buy bonds of a specific type,
maturity and risk profile -- 15 year corporates, for instance, or
tax-free municipals -- and pay out a coupon to investors -- often
monthly, rather than annually or semiannually like a regular bond.
The chief advantage of a bond fund is that it's
convenient. It's also true that when it comes to buying corporate
and municipal bonds, a professional manager backed by a strong
research organization can make better decisions than the average
individual investor. Consequently, if you want to dabble in junk
bonds or shelter your income with triple-tax-free New York City
30-year bonds, you may be better off going the easy route and
picking a good fund.
The disadvantage of a bond fund is that it's not a
bond. It has neither a fixed yield nor a contractual obligation to
give investors back their principal at some later maturity date --
the two key characteristics of individual bonds. Then there are the
fees and expenses that can cut into returns. Finally, because fund
managers constantly trade their positions, the risk-return profile
of a bond-fund investment is continually changing: Unlike an actual
bond, whose risk level declines the longer it is held by an
investor, a fund can increase or decrease its risk exposure at the
whim of the manager.
The other thing about building your own portfolio
of bonds is that you can tailor it to meet your circumstances,
meaning the bonds will mature precisely when you need them. A bond
fund cannot deliver that sort of precision."
[Source: "Bonds
vs. Bond Funds". Yahoo!
Bond Center. From SmartMoney.com:
One Bond Strategy.]
The Yield Curve as Your
Economic Forecaster
"The way the yield curve works is just common
sense. When short-term rates are high, savers can earn generous
returns on safe, liquid investments such as money-market funds, so
they have no need to take greater risks. But when short-term rates
fall, many people start to move their savings into higher-paying
investments like long-term bonds. As they switch money from savings
to bonds, they typically also move money into stocks that appear to
offer high returns. That shift from savings to long-term investments
actually helps finance the economy's growth. Here's the bottom line:
High short-term rates suck money out of the economy. Low short-term
rates put it to work, bidding up stock prices in the process."
[Source:
"Ahead
of the Curve: With Earnings Warnings Mounting, Things Look Bleak.
But My favorite Indicator is Flashing.." By Michael Sivey. Sivy
on Stocks. July 5, 2001. Money.com.
Yield and Duration
"Yield
and duration are the two most important and best known
characteristics of a bond. The chapters included in this part define
the two characteristics and examine their properties.
"Chapter
1 begins by specifying the principal and interest payments on a
Treasury bond and showing how the Street and the Treasury
conventionally compute a bond's yield. Chapter 2 describes how zero
coupon securities are stripped from a bond and states the
relationship between the price of a zero and its yield.
"Chapter
3 introduces the concept of duration and shows how duration can be
used to assess the sensitivity of the price of a bond to yield
changes. It also describes the process of immunization, or matching
the duration of an investment to an investor's investment horizon in
order to eliminate the risk of gains and losses attributable to
subsequent changes in interest rates. Chapter 4 examines in more
detail the behavior of duration through time and shows that duration
jumps sharply when a bond pays a coupon but otherwise declines on a
day-for-day basis with the passage of time. The chapter points out
the implications of this behavior for managing an immunized
portfolio and for yield curve analysis.
"Chapters
5 and 6 offer critical appraisals of yield and duration. Chapter 5
proposes a measure of the 'true' yield on a bond or zero coupon
security which, we suggest, is more useful in analytical
applications than the conventional yields described in the first two
chapters. Chapter 5 also questions the utility of matching the
duration of a bond to an investor's horizon when the shape as well
as the level of the yield curve can change. Chapter 6 reconsiders
bond immunization when interest rates change substantially, either
in a single large jump or in a sequence of small jumps."
[Source:
Fixed-Income
Analytics. By Kenneth D. Garbade. Cambridge, Mass.: MIT Press, c1996.
In netLibrary.]
