If you skim through The Wall Street Journal,you will see references to a wide variety
of bonds. This variety may seem confusing, but in actuality just a few characteristics
distinguish the various types of bonds.
While bonds are often viewed as relatively safe investments, one can certainly lose
money on them. Indeed, “riskless” long-term U.S. Treasury bonds declined by more
than 20 percent during 1994, and “safe” Mexican government bonds declined by 25
percent on one day, December 27, 1994. More recently, investors in Russian bonds
suffered massive losses when Russia defaulted. In each of these cases, investors who
had regarded bonds as being riskless, or at least fairly safe, learned a sad lesson. Note,
though, that it is possible to rack up impressive gains in the bond market. High-
quality corporate bonds in 1995 provided a total return of nearly 21 percent, and in
1997, U.S. Treasury bonds returned 14.3 percent.
In this chapter, we will discuss the types of bonds companies and government
agencies issue, the terms that are contained in bond contracts, the types of risks to
which both bond investors and issuers are exposed, and procedures for determining
the values of and rates of return on bonds.
Who Issues Bonds?
Abondis a long-term contract under which a borrower agrees to make payments
of interest and principal, on specific dates, to the holders of the bond. For exam-
ple, on January 3, 2003, MicroDrive Inc. borrowed $50 million by issuing $50 mil-
lion of bonds. For convenience, we assume that MicroDrive sold 50,000 individual
bonds for $1,000 each. Actually, it could have sold one $50 million bond, 10 bonds
with a $5 million face value, or any other combination that totals to $50 million.
In any event, MicroDrive received the $50 million, and in exchange it promised to
make annual interest payments and to repay the $50 million on a specified matu-
rity date.
Investors have many choices when investing in bonds, but bonds are classified into
four main types: Treasury, corporate, municipal, and foreign. Each type differs with
respect to expected return and degree of risk.
150 CHAPTER 4 Bonds and Their Valuation
Top Ten U.S. Corporate Bond Financings as of July 1999
Amount (Billions
Issuer Date of Dollars)
Ford July 9, 1999 $8.60
AT&T March 23, 1999 8.00
RJR Holdings May 12, 1989 6.11
WorldCom August 6, 1998 6.10
Sprint November 10, 1998 5.00
Assoc. Corp. of N. America October 27, 1998 4.80
Norfolk Southern May 14, 1997 4.30
US West January 16, 1997 4.10
Conoco April 15, 1999 4.00
Charter Communications March 12, 1999 3.58
Source: From Thomson Financial Securities Data, Credit Suisse First Boston as reported in The Wall Street Journal, July
12, 1999, C1. Copyright © 1999 Dow Jones & Co., Inc. Reprinted by permission of Dow Jones & Co., Inc. via Copyright
Clearance Center.
The textbook’s web site
contains an Excel file that
will guide you through the
chapter’s calculations. The
file for this chapter is Ch 04
Tool Kit.xls, and we encour-
age you to open the file and
follow along as you read the
chapter.
146 Bonds and Their Valuation
