Page 154 - CalcBus_Flipbook

18-18 Securities: Stocks & Bonds CH 18]

Buying Bonds
Corporate bonds are initially sold through the primary market. The primary market is where
securities are created. It's in this market that firms sell new stocks and bonds to the public for the
first time. An initial public offering, or IPO (Initial Public Offer), is an example of a primary market.
These trades provide an opportunity for investors to buy securities from the bank that did the initial
underwriting for a particular stock. An IPO occurs when a private company issues stock or bond to
the public for the first time.
Primary markets are facilitated by underwriting groups consisting of investment banks that set
a beginning price range for a given security and oversee its sale to investors. Once the initial sale is
complete, further trading is conducted on the secondary market, where the bulk of exchange trading
occurs each day. The corporate bond market is, essentially, an institutional market, with little
room for small investors. However, the small investor can buy newly issued corporate bonds from a
broker, and older bonds on the over-the-counter (OTC) market.
The minimum investment required to purchase a single bond is about $1,000, though bonds
are generally sold in $5,000 increments. Bonds can be purchased from several sources, including
investment and commercial banks, brokers, and firms that specialize in selling debt securities.
Corporations discount their bond offerings to the mortgage bankers and brokerage firms that
will handle the initial sale of the bonds. Mortgage bankers and brokerage firms will band together to
raise the funds the company is seeking to raise, paying the company the discount on their offering.
If a corporation wants to raise $47,000,000 cash it may issue $50,000,000 in bonds to be sold. The
Primary market purchases these bonds from brokerage firms, banks, bond traders and brokers, all
of which take a commission (a fee based on a percentage of the sale price) for facilitating the sale.
Bond prices are quoted as a percentage of the face value of the bond, based on $100. For example, if
a bond is selling at 96, it means that the bond may be purchased for 96% of its face value;
$50,000,000 in bonds then would cost the investors ($50,000,000 x 0.96 =) $48,000,000. The
corporation will then make the interest payments on the bond to the purchasers and when the
bonds mature pay the face value of the bond. The difference between the $47 million the company
received in cash and the $48 million the bonds are sold for in the primary market is the commission
fee earned by the mortgage bankers and brokerage firms.
Bond prices can be volatile and fluctuate in accordance with changing interest rates. Most bonds
pay a fixed interest rate, if interest rates in general fall, the bond’s interest rates become more
attractive, so the market bids up the price of the bond. Conversely, when interest rates rise the
market avoids lower fixed interest rates paid by a bond, and the bond price will decline. A $1,000
bond that is trading at $950 (5% discount) with a maturity in one year, the bonds rate of return at
the present time is approximately [($1,000 – 950) ÷ 950 x 100% =) 5.26%. For an investor to pay
$950 for this bond they must be happy receiving a 5.26% return.
Individuals purchasing bonds for their investment portfolio purchase at a rate of $1,000. Bonds
sold through exchanges are reported in the financial pages of daily newspapers with a business
section. Table 18.2 is a listing of 100 bonds as reported in the Wall Street Journal. While the tables
shown in the periodicals vary in format they provide the basic information needed to compare prices
of treasury, municipal, corporate and mortgage bonds. The pieces of information required to make
an informed decision include: the bonds interest rate quoted as the Coupon( % ), also referred to as
the coupon rate; The maturity date of the bond which is when the bond is due to be paid off; and its
current selling price as a percent of the original price (Current Value %). In Table 18.2, AerCap
Ireland Capital DAC is selling at 199% of the face value of the bond, whereas Albertsons is selling at
100% of its face value; compared with American Axle & Manufacturing which is selling for 99.25%
of its face value.

Current Cost to Annual cash %
Percent Maturity Price % Purchase 2 Yield for Return
Company Coupon(%) Date ($1,000) $1000bonds 2 Bonds Interest
(a) (b)
AerCap Ireland Capital DAC 3.875 Jan. 23,’28 199.000 $3,980.00 $77.50 1.95
Albertsons 5.750 March 15,’25 100.000 $2,000.00 $115.00 5.75
American Axle & Manufacturing 6.250 April 1,’25 99.250 $1,985.00 $125.00 6.30

Copyrighted Material