TABLE OF CONTENTSTable of contents_________________________________________1

Dedication_____________________________________________3

What are bonds _________________________________________4

Bond Markets Defined_________________________________________________4

Corporate Bond ______________________________________________ _______7

Corporate bonds distinct from common stock______________________________8

Types of Corporate Bonds _________________________________9

Corporate Bond Information and Features______________________10

Bond indentures:____________________________________________________10

Prospective covenants:_______________________________________________11

Bond valuation_____________________________________________________11

Broad categories of corporate debt:___________________________11

Corporate bond credit rating:___________________________________________13

Methods of Investing ____________________________________13

Risk analysis__________________________________________14

Corporate bond indices___________________________________15

External links__________________________________________16

Comparison to corporate bonds_____________________________17

Default Rates__________________________________________17

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How Big Is the Market, and Who Buys?_________________________19

How Corporate Bonds Are Taxed_____________________________20

Guide to Making the Most of Corporate Bonds:____________________21

_ Benefits of Investing in Corporate Bonds______________________23

Bond Funds___________________________________________24

Event Risk Mitigation (Special Features)____________________________26

conclusion____________________________________________28

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This report is dedicated to my respected teachers.

What are bonds?

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A bond is way of describing a company or government borrowing money - they are a

form of IOU. Investors lend money to a company for a fixed period and it pays them a

return for doing so. In recent years, returns from bonds have been very poor; often paying

less than you could get on a good savings account. A year ago, a cursory glance at the

performance tables for UK corporate bond funds revealed that not a single portfolio,

available to small investors, had made money in the previous 12 months.

But the tide has turned and experts are seeing strong reasons to invest. Jonathan Brown

low of City wealth management group, The Route, adds: 'Yields are very attractive on

corporate bonds but people are still less confident putting money with institutions –

especially in the light of what's happened at Northern Rock – credibility is in tatters. But

having exposure to corporate bonds in any investment portfolio is very important – it

diversifies assets.'

The reason for the turnaround for corporate bonds is largely due to the credit crunch.

Firms are willing to borrow money from bond buyers rather than banks, because banks

are being ultra-cautious in terms of lending at the moment. So to encourage bondholders,

companies are offering them more attractive returns.

Bond Markets Defined

● Municipal Securities Market

● Treasury Securities Market

● Federal Agency Securities Market

● Corporate Bond Market

● Money Market Instruments

● Mortgage Securities Market

● Asset-Backed Securities

4

Municipal Securities Market

Municipal securities are debt obligations issued by states, cities, counties, and other

governmental entities to raise money to build schools, highways, hospitals, and sewer

systems, as well as many other projects for the public good. Municipal securities are the

most important way that U.S. state and local governments borrow money to finance their

capital investment and cash flow needs. An important distinguishing characteristic of the

municipal securities market is the exemption of interest on municipal bonds from federal

income taxes. The implicit subsidy provided by the federal government permits

municipal issuers to compete effectively for capital in the domestic securities market.

There is currently in excess of $1.8 trillion in outstanding municipal debt, comprising

obligations of approximately 50,000 issuers.

Treasury Securities Market

The U.S. Treasury securities market is the largest and most liquid market in the world.

There is currently $3.1 trillion in outstanding marketable Treasury debt. The U.S.

Treasury issues three types of securities: bills, which have a maturity of less than 1 year;

notes, which have a maturity of 2 to 10 years; and bonds, which have a maturity of

greater than 10 years.

Federal Agency Securities Market

Federal agency debt is issued by various government-sponsored enterprises (GSEs)

which were created by Congress to fund loans to borrowers such as homeowners, farmers

and students. Through the creation of GSEs, the government addressed various public

policy concerns about the ability of members of these groups to borrow sufficient funds

at affordable rates. Most GSEs rely primarily on debt financing for their day-to-day

operations. Among the most active issuers of agency debt securities are: Federal Farm

Credit System Banks, Federal Home Loan Banks, Federal Home Loan Mortgage

Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae),

Student Loan Marketing Association (Sallie Mae) and Tennessee Valley Authority

(TVA). There is an estimated $2.3 trillion in agency debt currently outstanding.

5

Corporate Bond Market

Corporate debt securities are obligations issued by corporations for capital and operating

cash flow purposes. Corporate debt is issued by a wide variety of corporations involved

in the financial, industrial, and service-related industries. There is approximately $4.0

trillion in corporate debt currently outstanding. 

Money Market Instruments

Money market instruments include banker’s acceptances, certificates of deposit, and

commercial paper. Together these three instruments account for an estimated $2.5 trillion

in outstanding instruments. Banker’s acceptances are typically used to finance

international transactions in goods and services, and currently represent an estimated $5.2

billion market. Certificates of deposit (CDs) are large denomination negotiable time

deposits issued by commercial banks and thrift institutions, representing about $1.2

trillion. Commercial paper, which is short term unsecured promissory notes issued by

both financial and non-financial corporations, is currently a $1.3 trillion market.

Mortgage Securities Market

Mortgage securities represent an ownership interest in mortgage loans made by financial

institutions (savings and loans, commercial banks, or mortgage companies) to finance the

borrower's purchase of a home or other real estate. Mortgage securities are created when

these loans are packaged, or "pooled", by issuers or services for sale to investors. As the

underlying mortgage loans are paid off by the homeowners, the investors receive

payments of interest and principal. The majority of mortgage securities are issued and/or

guaranteed by an agency of the U.S. Government, the Government National Mortgage

Association (Ginnie Mae), or by government-sponsored enterprises such as the Federal

National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage

Corporation (Freddie Mac). Some private institutions, such as subsidiaries of investment

banks, financial institutions, and home builders, also package various types of mortgage

loans and mortgage pools. The securities they issue are known as "private-label"

mortgage securities, in contrast to "agency" mortgage securities issued and/or guaranteed

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by Ginnie Mae, Fannie Mae, or Freddie Mac. There is an estimated $4.0 trillion in

outstanding agency mortgage securities, with an additional $584 billion in outstanding

private label mortgage securities debt.

Asset-Backed Securities

Asset-backed securities (ABS) are certificates which represent an interest in a pool of

assets such as credit card receivables, auto loans and leases, or home equity loans. The

interest and principal payments on the pool of assets are passed through to investors,

typically institutional, who invest in highly rated, short-term liquid assets. The ABS

market has expanded rapidly in the past several years and there is approximately $1.5

trillion in debt currently outstanding.

Corporate BondA Corporate Bond is a bond issued by a corporation. It is a bond that a corporation

issues to raise money in order to expand its business.a corprate bond is a security issued

by a corporation that represents a promise to pay its bondholders a fixed sum of money at

a future maturity date,along with the periodic payments of debt.the fixed sum paid at

maturity is the bond’s principal also called its par or face value.the periodic interests are

called its coupons. The term is usually applied to longer-term debt instruments, generally

with a maturity date falling at least a year after their issue date.

Sometimes, the term "corporate bonds" is used to include all bonds except those issued

by governments in their own currencies. Strictly speaking, however, it only applies to

those issued by corporations. The bonds of local authorities and supranational

organizations do not fit in either category.

Corporate bonds are often listed on major exchanges (bonds there are called "listed"

bonds) and ECNs like MarketAxess, and the coupon (i.e. interest payment) is usually

taxable. Sometimes this coupon can be zero with a high redemption value. However,

7

despite being listed on exchanges, the vast majority of trading volume in corporate bonds

in most developed markets takes place in decentralized, dealer-based, over-the-counter

markets.

Some corporate bonds have an embedded call option that allows the issuer to redeem the

debt before its maturity date. Other bonds, known as convertible bonds, allow investors to

convert the bond into equity.

One can obtain an unfunded synthetic exposure to corporate bonds via credit default

swaps.

corporate bonds distinct from common stock.

For an investors point of view,corporate bonds represent an investment distinct from

common stock.the three most fundamental differences are these:

● Common stock represent an ownership claim on the corporation,whereas bonds

represent a creditor’s claim on the corporation.

● Promised cash flows-that is, coupon and principal-to be paid to the bondholders are

stated in advance when the bond is issued.by contrast,the amount and timing of the

dividends pey to the common stockholders may change at any time.

● Most corporate bonds are issued as callable bonds,which means that yhe bond issuer

has the right to back outstanding bonds before the maturity date of the bond issue.when a

bond issue is called,coupon payments stop and cash payment of a specified call price.by

contrast,common stock is almost never callable.

Types of Corporate Bonds

Mortgage Bonds:

8

These are bonds secured or backed by a specific asset such as real estate. Because these

are secured bonds they often pay a lower interest rate.

Convertible Bonds:

These are bonds that can be converted to a specific number of common stock. Those

who invest in convertible bonds would expect a rise in common stock value.

1. The number of common stock shares acquired in exchange for each converted

bond is called the conversion ratio:

C.R = # of shares acquired by conversion

2. The par value of convertible bond divided by its conversion ratio is called as

bond’s conversion price.

C.P = bond par value/conversion ratio

3. The market price of the common stock acquired by conversion times the bond’s

conversion ratio is called the bond’s conversion value.

C.V= price per share of stock* conversion ratio

Commercial Paper:

Normally used for short time periods such as 90 days. Commercial paper is normally an

IOU issued by the corporation to finance short term needs.

Debentures or Corporate Notes:

These bonds or notes are not secured by any assets. The only guarantee is the credit

worthiness of the issuer. These notes would typically pay a higher interest because they

are not secured.

Corporate Bond Information and Features

Call Feature:

9

Many corporate bonds will have a future call date at which time the bond may be

redeemed prior to the maturity date. If a corporate bond had a maturity date of 30 years it

would normally have a call date at the 10 year time period. If interest rates are lower in

10 years, the corporation will redeem the bond by issuing new bonds at a lower interest

rate. If general interest rates are higher than the interest being paid on the bond, the

corporation will not call the bond.

Put Feature:

This allows the bond holder to force the corporation to redeem the bond. This feature is

not used often.

Sinking Fund: Some corporate bonds require the corporation to set aside funds to

redeem future bond obligations. This is meant to be a safety feature to insure the bond

will be redeemed as agreed.

Income Tax

Interest income and capital gains from corporate bonds is fully taxable

Bond indentures:

A bond indenture is a formal written agreement between the corporation and

bondholders. It is an important legal document that spells out in detail the mutual rights

and obligation of the corporation and the bondholders with respect to the bond issue.

Indentures contracts are quite long, some time several 100 pages.

Indenture summary:

It provides the prospectus that was circulated when the bond issue was originally sold to

the public. Alternatively, a summary of the important features of an indenture is

published by debt rating agency.

The trust indenture act of 1939 requires that any bond issue subject to regulation by the

SEC, which includes most corporate bonds and note issue sold to the general public, must

have the trustee appointed to represent the interest of the bondholders.

10

Prospective covenants:

These agreements are designed to protect the bondholders by restricting the actions of a

corporation that might cause the deterioration in the credit quality of the bond issue.

Negative covenants:

1. The firm cannot pay the dividends to stockholders I excess of what is allowed by

the formula based on the firms earrings.

2. The firm cannot issue new bonds that are senior to the currently outstanding

bonds. Also, the amount of a new bond issue cannot exceed an amount specified

by a formula based on the firm’s net worth.

Positive covenants:

1. Proceeds from the sale of assets must be used either to acquire other assets of

equal value.

2. The firm must maintain the good condition of all asset pledged as a security for an

outstanding bond issue.

Bond valuation

Bond valuation is the process of determining the fair price of a bond. As with any

security or capital investment, the fair value of a bond is the present value of the stream

of cash flows it is expected to generate. Hence, the price or value of a bond is determined

by discounting the bond's expected cash flows to the present using the appropriate

discount rate.

Broad categories of corporate debt:

Corporate debt falls into several broad categories:

secured debt vs unsecured debt senior debt vs subordinated debt

Generally, the higher one's position in the company's capital structure, the stronger one's claims to the company's assets in the event of a default.

Corporate debt

11

The original speculative grade bonds were bonds that once had been investment grade at

time of issue, but where the credit rating of the issuer had slipped and the possibility of

default increased significantly. These bonds are called "Fallen Angels".

The investment banker Michael Milken realised that fallen angels had regularly been

valued less than what they were worth. His time with speculative grade bonds started

with his investment in these. Only later did he and other investment bankers at Drexel

Burnham Lambert, followed by those of competing firms, begin organising the issue of

bonds that were speculative grade from the start. Speculative grade bonds thus became

ubiquitous in the 1980s as a financing mechanism in mergers and acquisitions. In a

leveraged buyout (LBO) an acquirer would issue speculative grade bonds to help pay for

an acquisition and then use the target's cash flow to help pay the debt over time.

In 2005, over 80% of the principal amount of high yield debt issued by U.S. companies

went toward corporate purposes rather than acquisitions or buyouts.[citation needed]

Debt repackaging and subprime crisis

High-yield bonds can also be repackaged into collateralized debt obligations (CDO),

thereby raising the credit rating of the senior tranches above the rating of the original

debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating

requirements of pension funds and other institutional investors despite the significant risk

in the original high-yield debt.

High-yield bond indices

High-yield bond indices exist for dedicated investors in the market. Indices for the broad

high yield market include the CSFB High Yield II Index (CSHY), the Merrill Lynch

High Yield Master II (H0A0), and the Bear Stearns High Yield Index (BSIX). Some

investors, preferring to dedicate themselves to higher-rated and less-risky investments,

use an index that only includes BB-rated and B-rated securities, such at the Merrill Lynch

BB/B Index. Other investors focus on the lowest quality debt rated CCC or Distressed

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securities, commonly defined as those yielding 1000 basis points over equivalent

government bonds

Corporate bond credit rating:

When a corporation selles a new bond issue to investors, it usually subscribes to several

bond rating agencies for a credit evaluation of the bond issue.each contracted rating

agency then provides a credir rating.An assessment of the credit quality of a bond issue

based on the issuer’s financial condition.

Established rating agencies in united states include Duff and Phelps,(D&P);

McCarthy,Crisanti and Maffei(MCM),Noody’s investers service (Moody,s) and Standerd

& Poor’s corporation,(S&P).these companies regulerly publish updated credit ratings for

thousands of domestic and international bond issue.

Methods of Investing

Direct and Indirect. Corporate bonds may be purchased individually or can be accessed

through mutual funds.

Potential Risks in Corporate Bond Ownership

Default: The bond issuer may not be able to pay the agreed upon interest or redeem the

value of the bond at maturity.

Market: Changes in general interest rates can affect the value of a bond. A bond sold

prior to the maturity date may not have the same value because of outside influences such

as higher interest rates.

Investment

Corporate bonds are used because most are a higher arte of return than municipal bonds.

13

These bonds generally provide a safe and reliable income stream.

Tips Regarding Corporate Bonds

- Always know the bond rating of the bond you are considering. There are numerous

bond rating services available to provide this information.

- If the bond has a call feature, find out if they will pay a premium to you if it is called.

- Bonds are debt instruments; make certain you fully understand any risk you may be

taking. Very high interest rates can mean low security and safety

Risk analysis

Compared to government bonds, corporate bonds generally have a higher risk of default.

This risk depends, of course, upon the particular corporation issuing the bond, the current

market conditions and governments to which the bond issuer is being compared and the

rating of the company. Corporate bond holders are compensated for this risk by receiving

a higher yield than government bonds.

Consequently, this default risk can be quantified using spread analysis, which seeks to

determine the difference in yield between a given corporate bond and a risk-free treasury

bond of the same maturity. Common statistics used include Z-spread and option adjusted

spread (OAS).

Corporate bond indices

14

Corporate bond indices include the Barclays Corporate Bond Index, the Citigroup US

Broad Investment Grade Credit Index, and the Dow Jones Corporate Bond Index.

A government bond is a bond issued by a national government denominated in

the country's own currency. Bonds issued by national governments in foreign

currencies are normally referred to as sovereign bonds. The first ever

government bond was issued by the English government in 1693 to raise money

to fund a war against France. It was in the form of a tontine. Risk

Government bonds are usually referred to as risk-free bonds, because the government can

raise taxes to redeem the bond at maturity. Some counter examples do exist where a

government has defaulted on its domestic currency debt, such as Russia in 1998 (the

"ruble crisis"), though this is very rare.

As an example, in the US, Treasury securities are denominated in US dollars and are the

safest US dollar investments.[citation needed] In this instance, the term "risk-free" means free of

credit risk. However, other risks still exist, such as currency risk for foreign investors (for

example non-US investors of US Treasury securities would have received lower returns

in 2004 because the value of the US dollar declined against most other currencies).

Secondly, there is inflation risk, in that the principal repaid at maturity will have less

purchasing power than anticipated if the inflation outturn is higher than expected. Many

governments issue inflation-indexed bonds, which should protect investors against

inflation risk. The protection has been questioned by John Williams' ShadowStats.com,

which claims that government-calculated inflation is understated by as much as 5 percent,

which also makes inflation-indexed bonds yield a loss.

External links

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Government bonds explained in simple terms

v • d • e

Bond market

Bond · Debenture · Fixed income

Types of bonds by issuerAgency bond · Corporate bond (Senior debt, Subordinated debt) · Distressed debt · Emerging market debt · Government bond · Municipal bond · Sovereign bond

Types of bonds by payout

Accrual bond · Auction rate security · Callable bond · Commercial paper · Convertible bond · Exchangeable bond · Fixed rate bond · Floating rate note · High-yield debt · Inflation-indexed bond · Inverse floating rate note · Perpetual bond · Puttable bond · Reverse convertible · Zero-coupon bond

Securitized ProductsAsset-backed security · Collateralized debt obligation · Collateralized mortgage obligation · Commercial mortgage-backed security · Mortgage-backed security

DerivativesBond option · Credit derivative · Credit default swap · CLN · Inflation derivatives

PricingAccrued interest · Bond valuation · Clean price · Coupon · Day count convention · Dirty price · Maturity · Par value

Yield analysisNominal yield · Current yield · Yield to maturity · Yield curve · Bootstrapping · Bond duration · Bond convexity  · TED spread

Credit and spread analysisCredit analysis · Credit risk · Credit spread · Yield spread · Z-spread · Option adjusted spread

Interest rate models

Short rate models · Rendleman-Bartter · Vasicek · Ho-Lee · Hull-White · Cox-Ingersoll-Ross · Chen · Heath-Jarrow-Morton · Black-Derman-Toy · Brace-Gatarek-Musiela

Organizations

Commercial Mortgage Securities Association (CMSA) · International Capital Market Association (ICMA) · Securities Industry and Financial Markets Association (SIFMA

16

In the United States, a municipal bond (or muni) is a bond issued by a city or other local

government, or their agencies. Potential issuers of municipal bonds include cities,

counties, redevelopment agencies, school districts, publicly owned airports and seaports,

and any other governmental entity (or group of governments) below the state level.

Municipal bonds may be general obligations of the issuer or secured by specified

revenues. Interest income received by holders of municipal bonds is often exempt from

the federal income tax and from the income tax of the state in which they are issued,

although municipal bonds issued for certain purposes may not be tax exempt.

Comparison to corporate bonds

Because municipal bonds are most often tax-exempt, comparing the coupon rates of

municipal bonds to corporate or other taxable bonds can be misleading. Taxes reduce the

net income on taxable bonds, meaning that a tax-exempt municipal bond has a higher

after-tax yield than a corporate bond with the same coupon rate.

This relationship can be demonstrated mathematically, as follows:

where

rm = interest rate of municipal bond

rc = interest rate of comparable corporate bond

t = tax rate

For example if rc = 10% and t = 38%, then

A municipal bond that pays 6.2% therefore generates equal interest income after taxes as

a corporate bond that pays 10% (assuming all else is equal).

Alternatively, one can calculate the taxable equivalent yield of a municipal bond and

compare it to the yield of a corporate bond as follows:

Because longer maturity municipal bonds tend to offer significantly higher after-tax

yields than corporate bonds with the same credit rating and maturity, investors in higher

17

tax brackets may be motivated to arbitrage municipal bonds against corporate bonds

using a strategy called municipal bond arbitrage.

Some municipal bonds are insured by monoline insurers that take on the credit risk of

these bonds for a small fee.

Default Rates

The historical default rate for municipal bonds is lower than that of corporate bonds. The Municipal Bond Fairness Act (HR 6308), introduced September 9 2008, included the following table giving bond default rates up to 2007 for municipal versus corporate bonds by rating and rating agency.

Cumulative Historic Default Rates (in percent)------------------------------------------------------------------------ Moody's S&P Rating categories --------------------------------------- Muni Corp Muni Corp------------------------------------------------------------------------Aaa/AAA......................... 0.00 0.52 0.00 0.60Aa/AA........................... 0.06 0.52 0.00 1.50A/A............................. 0.03 1.29 0.23 2.91Baa/BBB......................... 0.13 4.64 0.32 10.29Ba/BB........................... 2.65 19.12 1.74 29.93B/B............................. 11.86 43.34 8.48 53.72Caa-C/CCC-C..................... 16.58 69.18 44.81 69.19Investment Grade................ 0.07 2.09 0.20 4.14Non-Invest Grade................ 4.29 31.37 7.37 42.35All............................. 0.10 9.70 0.29 12.98------------------------------------------------------------------------

How Big Is the Market, and Who Buys?

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The corporate bond market is large and liquid, with daily trading volume estimated at

$15.1 billion. Issuance for 2008 was an estimated $702.4 billion.* The total market value

of outstanding corporate bonds in the United States at the end of 2008 was approximately

$6.1 trillion as of Q3 2008.**

Most corporate bonds trade in the over-the-counter (OTC) market. This market does not

exist in a central location. It is made up of bond dealers and brokers from around the

country who trade debt securities over the phone or electronically. Market participants

are increasingly using electronic transaction systems to assist in the trade execution

process. Some bonds trade in the centralized environments of the New York Stock

Exchange (NYSE) and American Stock Exchange (AMEX), but the bond trading volume

on the exchanges is small. The OTC market is much larger than the exchange markets,

and the vast majority of bond transactions, even those involving exchange-listed issues,

take place in this market.

* Includes all non convertible debt, MTNs, and Yankee bonds, but excludes all issues

with maturities of one year or less, CDs, and federal agency debt. Source: Thomson

Financial as of 12/31/08.

Investors in corporate bonds include large financial institutions, such as pension funds,

endowments, mutual funds, insurance companies and banks. Individuals, from the very

wealthy to people of modest means, also invest in corporates because of the many

benefits these securities offer.

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How Corporate Bonds Are Taxed

The following basic information addresses the tax aspects for individuals of investing in

corporate bonds. For advice about your specific situation, you should consult your tax

adviser.

Interest

The interest you receive from corporate bonds is subject to federal and state income tax.

(If you own shares in bond mutual funds, your interest income will come to you in the

form of “dividends” from the fund, but these are fully taxable and are not eligible for the

maximum 15% tax rate that otherwise applies to dividends.)

Gains and losses

You may generate capital gains on a corporate bond if you sell it at a profit before it

matures. If you sell it up to a year from purchase, the gains are taxed at your ordinary

rate. If you sell it more than a year from purchase, your capital gains are considered long-

term and are currently taxed at a maximum rate of 15%.

Conversely, if you sell a bond for less than you paid, you may incur a capital loss. You

may offset an unlimited amount of such losses dollar-for-dollar against capital gains you

have realized on other investments (bonds, stocks, mutual funds, real estate, etc.). If your

losses exceed your gains, you may currently deduct up to $3,000 of net capital losses

annually from your ordinary income. Any capital losses in excess of $3,000 are carried

forward and can be used in future years. (These rules apply to the sale of shares in bond

funds as well as to individual bonds.)

Original-issue discount

20

When bonds are issued at substantially less than par (face) value, the difference between

the face amount and the initial offering price is known as original-issue discount. Zero-

coupon bonds are the best-known variety of this category of bonds.

The tax treatment of original-issue-discount bonds is particularly complicated, so if you

plan to invest in them, it is essential to consult your tax attorney or adviser. During the

time you own original-issue-discount bonds, you will pay tax each year on a portion of

the discount (even though you do not receive it in cash). However, if you hold them to

maturity, you do not pay capital gains or other taxes on the amount by which the face

value you receive exceeds the discounted amount you paid for the bonds. The reason is

that you paid taxes on that excess incrementally each year that you held the bonds.

Guide to Making the Most of Corporate Bonds:

How to become well-versed in corporate bonds

By Felicia R. Blue

You can quickly obtain corporate bond information on the Internet without relying on a

corporate bond consultant for this information. One thing you will learn is that corporate

bonds differ from stocks. You don’t own any shares. Instead, the company is borrowing

money from you. In return, it pays you interest over a certain period of time.

One of the reasons why corporate bond investing is attractive is that investors can get

higher yields. When looking at corporate bonds for sale as potential investments, do the

following:

1. Understand corporate bonds relative to other types of investments.

2. Learn about corporate bonds by following corporate bond indices.

3. Examine the idea of corporate bond funds rather than individual bonds.

Action Steps

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The best contacts and resources to help you get it done

Learn how corporate bonds differ from other investments

If you're going to buy corporate bonds, you must first understand what they are. Websites

will explain how corporate bonds differ from stocks. They will also explain why

corporations issue high-yield bonds. In addition, you will also understand the difference

between high yield corporate bonds versus fixed-rate bonds. Finally, these websites

explain how and why interest rates have an impact on bond prices and yields.

I recommend:  PIMCO provides solid corporate bond information. For example, it explains

why corporations issue corporate bonds. They may want to expand their operations or

upgrade their equipment. Securities Industry and Financial Markets Association also

offers corporate bond market information where it explains the different types of

corporate bond investing.

Study corporate bond indices to get more knowledge on corporate bonds

Study corporate bond indices if you are looking for an individual corporate bond to invest

in. Corporate bond indices can provide you some leads. Another reason to study

corporate bond indices is that you can get their total returns. Not only will you get

corporate bond listings, you'll learn the latest information on prices, volume, coupons,

and accrued interest.

I recommend:  You will want to look at Bloomberg, since it has two corporate bond indices,

NASD/Bloomberg U.S. Corporate Bond Indexes and NASD/Bloomberg Investment

Grade U.S. Corporate Bond Index. The website provides the latest in price, volume, and

yield. Dow Jones Indexes is another website you will want to visit. It focuses on high-

grade U.S. corporate notes. If you’re interested in historical performances on the

corporate bond index, Dow Jones Indexes provides this information as well.

Learn about corporate bonds mutual funds as an alternative to individual bonds

22

Perhaps you don't want to invest in individual corporate bonds. You think they're too

risky. Look into corporate bond funds. Corporate bond funds can be considered safer to

invest in, and you won't have to put up much of your money in corporate bond investing.

This is because other investors invest in these securities, as well. As a result, the bond

investment management team can diversify by investing in other corporate bonds. This

helps to reduce risks.

I recommend:  T.Rowe Price explains who should invest in corporate bond funds; it also has

a corporate bond mutual fund you can invest in. Educated Investor also provides good

information on corporate bond funds.

Tips & Tactics

Helpful advice for making the most of this Guide

Consider subscribing to a financial newsletter for making the most of corporate bonds.

Newsletters can provide a wealth of information, such as reading interviews on corporate

bond traders. You can also get in-depth information on both corporate bonds and

corporate bonds funds.

Benefits of Investing in Corporate Bonds

Investors buy corporates for a variety of reasons:

Attractive yields. Corporates usually offer higher yields than comparable-maturity

government bonds or CDs. This high-yield potential is, however, generally accompanied

by higher risks.

Dependable income. People, who want steady income from their investments, while

preserving their principal, may include corporates in their portfolios.

Safety. Corporate bonds are evaluated and assigned a rating based on credit history and

ability to repay obligations. The higher the rating, the safer the investment as measured

by the likelihood of repayment of principal and interest. (See Understanding Credit Risk.)

23

Diversity. Corporate bonds provide an opportunity to choose from a variety of sectors,

structures and credit-quality characteristics to meet your investment objectives.

Marketability. If you must sell a bond before maturity, in most instances you can do so

easily and quickly because of the size and liquidity of the market. (See Marketability.)

 

All information and opinions contained in this publication were produced by the

Securities Industry and Financial Markets Association from our membership and other

sources believed by the Association to be accurate and reliable. By providing this general

information, the Securities Industry and Financial Markets Association makes neither a

recommendation as to the appropriateness of investing in fixed-income securities nor is it

providing any specific investment advice for any particular investor. Due to rapidly

changing market conditions and the complexity of investment decisions, supplemental

information and sources may be required to make informed investment decisions.

Bond Funds

Many investors who want to reap the good returns available in the corporate bond market

buy shares in bond mutual funds instead of individual bonds—or in addition to individual

bonds. They do so for the same reasons investors have flocked to mutual funds of all

kinds in recent years—diversification, professional management, modest minimum

investments, automatic dividend reinvestment, and other convenience features.

Diversification is an especially important advantage of bond funds. Many investors in

individual bonds buy only a few securities, thus concentrating their risk. A fund manager,

by contrast, spreads credit risk, interest-rate risk and, indeed, all other kinds of risk, over

many bonds. Different issuers, sectors, credit ratings, coupons and maturities are all

represented in a diversified portfolio.

However, lower risk does not mean no risk. All the underlying risks that affect bonds

affect bond funds—but not as sharply. You should be aware that prices of bond fund

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shares fluctuate inversely with interest rates, just as individual bonds’ prices do, and

when you sell fund shares, they may be worth more or less than you paid for them.

The turmoil has left investors with a headache as household names take a battering and

they search for a sound place to invest. Some experts suggest corporate bond funds could

deliver the required results.

The classification of a bear market is a sharp slide in stock value over a prolonged period

or more specifically, a 20% drop in two months. The last bear market, which

encompassed three years of investment turmoil, ended in March 2003.

The bears are back. At one point on Tuesday(July 8), the FTSE 100 index of the UK's

largest firms collapsed by more than 150 points to 5358.7, compounded by fears a

recession is on the way.

Ted Scott, fund manager of the F&C UK Growth & Income portfolio, said: 'At present

the UK economy has only just begun to slow after a robust 2007 when GDP growth was

above trend.

'Despite months of gloomy headlines, house prices have so far only fallen a few per cent

from their peaks and unemployment is low, albeit rising. Therefore, if a recession does

become a reality - and the risks lean that way - there could be further to go.'

Over the past year the market has witnessed shares in many household names tumble -

M&S is down nearly 70% from its 2007 high, while Halifax Bank of Scotland has

endured a near 80% fall.

During the last similar period, the 2000-2003 bear market, equities tumbled from 1999

highs when the FTSE 100 touched the 7,000-mark and bond funds took centre stage as

investors fled markets in search of a safehaven for their cash.

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Event Risk

Corporate bonds are like no other in that they have an implied event risk. Takeovers, corporate

restructuring, and even LBO's can have dramatic consequences to a bonds credit rating and even price.

Unless you were acting on inside information, it was nearly impossible to predict these dramatic shifts

in a company and therefore; corporate bond issuers were forced to provide additional bond features to

remove some of the uncertainty associated with corporate bonds.

Event Risk Mitigation (Special Features)

Poison pill provisions, floating rate notes, and putable bonds are a few key features that were added

to corporate bonds to ease the investors' mind.

Poison Pill Provision

The poison pill provision is probably the most important risk prevention measure that a corporation

can make; it allows shareholders to buy the stock of the acquiring company or more of the same stock

at a heavily discounted price, usually half of the market rate, during a takeover situation. The

provision attempts to thwart would be takeover attempts by forcing the acquirer to negotiate terms

with the board of directors on the terms of the takeover. If the board is amenable to the terms, they

will recant the pill. If not, the pill could be triggered; and shareholders can exercise the option to

purchase shares at a deep discount. This would have negative ramifications to the acquirer as it would

dilute their interest in the company.

Floating Rate Notes

Floating rate notes (FRN) are corporate bonds that have a variable coupon structure to protect

purchasers against interest rate risk. The coupon is reset usually every three months using a

benchmark index as a basis; usually a short term treasury instrument or LIBOR. Sometimes, floaters

will have a floor in place to provide that much more protection to the corporate bond holder against

interest rate movements. The idea behind a floating rate note is to protect the bond holder against rate

fluctuations and at the same time keeping the bond value close to par.

Putable Bonds

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A corporate bonds with a putable feature allows the bond holder to return, or "tender", the bond back

to the issuer at par before the bond's maturity date. This feature is designed to protect a bonds value

against interest rate fluctuations. The intervals in which this put feature can be executed are specified

in the bond indenture. Effectively, a corporate bond with a putable option turns the security into a

shorter term instrument.

Putable bonds are not as great in interest rate environments that are shifting sharply; this is so due to

the fact that the bond holder will need to wait for specific intervals in which they may tender the bond

back to the issuer. Additionally, similar to its callable bond counterpart, the putable bond carries an

option premium which will reduce your yield.

Credit Risk

Analyzing credit risk for corporate bonds is a little more complex than a more simple method in which

municipal bonds are be evaluated. Corporate bonds have a tiered repayment structure, similar in

concept to the one that a CMO has. Each bond issuer may have multiple issuances; each of these

issues will receive different ratings from the credit agencies due to the fact that they have different

repayment structures and conditions. For example, there may be a senior class of debt, and then a

subordinated class of debt which is less senior. Obviously, the senior class will bear a higher credit

rating.

Junk Bonds

The term "junk bonds" refers to high-yield corporate bond issuances which are classified as non-

investment grade. They are speculative in nature and have very low credit ratings. Standard and Poors

defines junk bonds as issues with a rating lower than BBB while Moody's classifies a bond as junk

below Baa3. Typically, issuers of junk bonds have just gotten into deep financial issues and need to

raise cash immediately; other times, issuers may be trying to re-emerge from bankruptcy. In either

case, the corporate bonds credit quality is low and investors who purchase them are speculating on the

future of the company. Junk bonds are typically purchased at tremendous discounts to par; many times

you can get them for 10 to 20 cents on the dollar.

While junk bonds may seem to be a risky proposition; nearly 1 out of every 5 companies are rated in

"junk" status. The market for these bonds has become more diversified; including some bigger names

and more recently, public growth companies looking for financing. Junk bonds actually provide a

portfolio with diversification since these companies typically are on their own page and doing their

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own thing regardless of what the general market is doing. Additionally, junk bond yields are quite a

bit higher than their treasury equivalents. If you can spot the right investment, the compounding

interest can be quite staggering over the life of the bond.

In a nutshell, if you plan on investing in junk bonds, you can expect a riskier investment with great

returns if it works out. Be prepared to lose your money if the company does not work out as you

thought; therefore, never throw a large portion of your portfolio into these investments.

Conclusion

The corporate bond market can offer very high yields but they come with a price; extra risk. We spoke

about a few ways to mitigate that risk but also run your numbers and remember that treasury

equivalents in term may have lower yields but offer different tax structures. Therefore, run your

taxable equivalent yield formula and solve for tax exempt yield to see if the corporate bond provides

you with the added risk premium when compared to a riskless treasury bond. When buying a

corporate bond, be sure to ask the key questions: What is the credit rating? Is there a putable option?

Is there a callable option embedded into the bond? How liquid is the bond? Is the corporate bond

listed on an exchange (these will tend to have more liquidity)?

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