Chestnut & Cedar Stock Report

Types of Bonds
- Corporate Bonds

- Municipal Bonds

- Asset Backed Securities

- High-Yielding Securities –
Junk Bonds

- Enhanced Trust- Preferreds

- Zero-Coupon Bonds

- STRIPS Bonds

- Internotes

- International Bonds

- Brady Bonds

Corporate Bonds

Corporate bonds are debt obligations issued by a corporation to raise money needed to fund operations, grow the business, or refinance existing debt (at longer maturities or lower rates). Bonds offer investors a way of preserving their capital while getting a steady and predictable cash flow stream.

Corporate bonds can be either unsecured debentures or secured by a particular asset. Sinking fund bonds are also available. They require the issuer to retire a certain percentage of the outstanding bonds each year, either by open market purchases or by a lottery. There are also guaranteed bonds, where in the event of a default by the issuer, a third party, usually a bank or insurance company, will repay the bondholders.

Bonds are normally issued in denominations of $1,000. The original bond principal, called the par value, is returned at maturity; therefore, the maturity date is when you get your principal investment back. The term of maturity is the time between when the bond is issued, to when the principal is repaid. Most bonds have terms ranging from 1 to 30 years. Duration is a weighted average term that is used by institutional investors. The coupon payment frequency is typically twice a year (semi-annually). Interest is usually a fixed coupon rate; however, floating (variable) interest rate bonds are also available.

The rate of interest paid on the par value is called the coupon rate. The price of bonds will fluctuate on the open market with changes in the interest rates. Bond prices are quoted as a percentage of par value, which is 100. When the market rate is less than the coupon rate, the bond sells at a bond premium and the price trades over 100. When the market rate is greater then the coupon rate, the bond sells at a bond discount; the bond’s price will be under 100.

Clipping Coupons - In my parents’ days, interest payments were called coupons. A bond would have interest coupons attached. Holders would cut out the coupons and redeem them at their local banks. These are the bearer bonds which, if not registered, could be used as a way to keep one’s money out of public view. Today, as the world becomes digital, bearer bonds are being phased out; most US banks no longer cash the coupons. The paying agent, however, normally a bank or broker, will honor the coupons, usually by mail. Bearer bonds are, however, still popular overseas. The expression “clipping coupons” was not originally about grocery store sales, but about how rich people earned a living.

Corporate bonds are classified into the following categories:

Term	Maturity
Short-term notes	One to five years
Medium term notes/bonds	Five to twelve years
Long-term bonds	Greater than twelve years

Rate Summary: In a normal rate environment (when the yield curve slopes upward to the right) the longer the maturity (term), the higher the yield; the lower the credit rating, the higher the yield. Conversely, short-term bonds with high credit ratings return the least.

Comparative Rate Analysis for Selective Fixed Income Securities: Below is a comparative analysis of interest rates on high quality, 30 year, debt instruments as of October 12, 2005. The list is designed to demonstrate how corporate rates compare with similar debt instruments. Keep in mind that rates are fluid and are constantly changing.

·        Corporate AAA    5.59%

·        Agency       AAA    5.00%

·        Treasury     AAA    4.66%

·        Municipal   AAA    4.48%

Historical Corporate Bond Rate Trends: Corporate bonds are attractive because they return a higher yield than government securities. Normally, the longer the maturity, the higher the yield. Additionally, bond prices fluctuate inversely with the change in interest rates. As interest rates decline, bond prices increase, and vice versa.

Since 1981 there has been a gradual decline in long-term Aaa corporate bond yields, from approximately 15% in 1981 to 5% in June 2005. Recently, rates have ticked up, in response to inflation concerns and an overheated housing market.

AAA Corporate Bond Yield Trends

Corporate bonds are liquid investments, in that they trade on the exchanges. It is difficult to know, however, if you are realizing fair value.

Corporate bond interest and capital gains/ (losses) are subject to federal and state income taxes.

Bonds also have various distinctions; the most common are: call, convertible, and estate put features:

The call (redemption) provision allows the issuing company to repurchase the bonds before their scheduled maturities. There is usually a call schedule, with call dates and prices, issued with these bonds. Usually, if interest rates decline, the company will reissue lower yielding bonds to reduce their interest payments. Investors can protect themselves from the call risk by purchasing non-callable bonds. Most corporate bonds have some sort of protection from early payoffs.
Convertible bonds allow the holders to participate in the upside capital appreciation potential of the common shares. These bonds can convert into a set number of company shares. Convertibles are of interest to investors who need a predictable cash flow and would appreciate some juice on the bond price

Convertible bonds are really fixed-income debt instruments with attached embedded warrants. Convertibles are priced less than regular bonds because of the value of the attached warrants. In practice, when the stock trades above the bond’s conversion price, both instruments trade lock step in parity. When the stock drops below the conversion price, the floor of the bond’s price will be cushioned by the bond’s yield.

In recent years, investment bankers created the synthetic convertible bond. The bond of one company is combined with a warrant of another company. This creates a fixed-income product, with the return potential of a convertible security. This can get wild, because the combinations are limitless.

Estate put feature allows the estate of the bondholder to sell back the bond to the issuer at par value, in the event of the bondholder’s death.

Buying bonds is weighing safety versus yield. Preservation of capital should always win over yield trade-off decisions.