Chapter 12
The Bond Market
Purpose of the Capital Market
Capital Market Participants
Capital Market Trading
Types of Bonds
Treasury Notes and Bonds
Treasury Bond Interest Rates
Treasury Inflation-Protected Securities (TIPS)
Treasury STRIPS
Agency Bonds
Case: The 2007–2009 Financial Crisis and the Bailout of Fannie Mae and Freddie Mac
Municipal Bonds
Risk in the Municipal Bond Market
Corporate Bonds
Characteristics of Corporate Bonds
Types of Corporate Bonds
Financial Guarantees for Bonds
Current Yield Calculation
Current Yield
Finding the Value of Coupon Bonds
Finding the Price of Semiannual Bonds
Investing in Bonds
◼ Overview and Teaching Tips
Chapter 12 examines securities that have an original maturity that is greater than one year. These types of
securities are traded in capital markets and the best known securities are stocks and bonds. This chapter
focuses on the characteristics of the bonds while the next chapter extends the capital market discussion to
stocks. Capital markets are used for long-term financing and investments. The beginning of the chapter
discusses the purpose of and the participants in the capital market so students will get a better understanding
of the topic when it is discussed in depth in later sections. We explore two categories of capital markets:
bonds and stocks. Show the students Table 1 because it gives a clear understanding of the different types
of Treasury securities. Treasury securities are free of default risk, but not risk-free, and have a very low
interest rate. Bonds issued by local, county, and state governments are municipal bonds and are used to
64 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
finance public interest projects. Point out to students that municipal bonds are not free of default. Corporate
bonds usually have a face value of $1,000 and can be redeemed at anytime.
The chapter concludes by showing how to compute the value of bonds. An example focuses specifically
on valuing semiannual bonds. This valuation model can be used to show that interest-rate risk will affect
the wealth of investors in bonds.
◼ Answers to End-of-Chapter Questions
1. Investors use capital markets for long-term investment purposes. They use money markets, which
have lower yields, primarily for temporary or transaction purposes.
3. The primary market is for securities being issued for the very first time, and the issuer receives the
4. The par value is the amount the issuer will pay the holder when the bond matures. The coupon interest
5. Treasury bills mature in less than 1 year, Treasury notes mature in 1 to 10 years, and Treasury bonds
mature in 10 to 30 years.
7. Agencies that issue securities include Ginnie Mae (formerly the Government National Mortgage
8. Firms like having the flexibility to adjust their capital structure by paying off debt they no longer
9. A sinking fund contains funds set aside by the issuer of a bond to pay for the redemption of the bond
10. The list of terms of a bond is known as the indenture.
11. Capital market securities may be sold in a public offering or in a private placement. In a public
offering, investment bankers register the security with the SEC and market it through a network of
Chapter 12: The Bond Market 65
◼ Quantitative Problems
1. A bond pays $80 per year in interest (8% coupon). The bond has 5 years before it matures at which
time it will pay $1,000. Assuming a discount rate of 10%, what should be the price of the bond
(Review Chapter 3)?
2. A zero coupon bond has a par value of $1,000 and matures in 20 years. Investors require a 10%
annual return on these bonds. For what price should the bond sell? (Note: Zero coupon bonds do not
pay any interest.) (Review Chapter 3)?
3. Consider the two bonds described below:
Bond A
Bond B
Maturity
15 yrs
20 yrs
Coupon Rate
(Paid semiannually)
10%
6%
Par Value
$1,000
$1,000
a. If both bonds had a required return of 8%, what would the bonds’ prices be?
b. Describe what it means if a bond sells at a discount, a premium, and at its face amount
(par value). Are these two bonds selling at a discount, premium, or par?
c. If the required return on the two bonds rose to 10%, what would the bonds’ prices be?
Solution:
4. A 2-year $1,000 par zero-coupon bond is currently priced at $819.00. A 2-year $1,000 annuity is
currently priced at $1,712.52. If you want to invest $10,000 in one of the two securities, which is a
better buy? You can assume
a. the pure expectations theory of interest rates holds,
b. neither bond has any default risk, maturity premium, or liquidity premium, and
c. you can purchase partial bonds.
