Question

1.  Four different classes of bonds and its characteristics. Which class of bonds tends to have the least amount of risk and whyß

2. What are 5 financial institutions that historically participate in the bond market? what are the goals for each institution?

3. regarding the term bond yield how does an investor really a return on a bond investment?

Answer 1

1) Four classes of bonds are

· Treasury bonds: Treasury bonds are issued by the federal government and are of highest quality. The default risk on these bonds is lowest as they are backed by the government so the yield on these bonds is also lowest.

· High-yield bonds: High yield bonds are also called speculative bonds as the yield on these bonds is very high but the default risk is also very high.

· Investment grade corporate bonds: These bonds are issued by corporations which are of highest rating and the yield on these bonds is slightly higher than treasury bond but lower than speculative bonds.

· Municipal Bonds: Municipal bonds are bonds issued by the municipal corporation and though the yield on these bonds are lower than the corporate bonds these bonds are tax free, so the return is high comparative to after tax similar corporate bond.

Treasury bonds are considered to be least risky because they are backed by the federal government.

2) The five financial institutions that participate in the bond markets are

· Commercial banks

· Pension funds

· Mutual funds

· Non-banking financial institution

· Insurance companies

The goal of each firm is to either borrow money or invest in the bond market. Commercial bank use bond market raises funds as well as invest their capital. Pension funds and mutual funds mostly invest in the bond market. Non-banking financial companies like housing loan companies, and insurance companies they also use the bond market for raising funds as well as investing their excess capital.

3) The bond yield of an investor consists of the periodic coupon income, reinvestment of coupon as well as capital gain or loss on the sale of the bond. So, the yield on the bond is the total return that an investor receives from investing in the bond. The yield on the bond is calculated as the rate at which the current price of the bond is equal to the present value of all future cash flow associated with the bond.