Bond Worksheet
1.) Name four types of bonds (who issues them) and discuss their risk exposures. The four specific types of bonds are treasury, corporate, municipal and foreign bonds. Treasury bonds are sometimes referred to as government bonds and issued by the federal government. These types of bonds have no default risk. A corporate bond is issued by business firms. These types of bonds are exposed to default risk. Different corporate bonds have different levels of default risk depending on the issuing company’s characteristics and the terms of specific bond. Municipal bonds are issued by state and local governments. They’re exposed to some default risk but have a major advantage. The interest earned on most munis is exempt from federal taxes and from state taxes if the holder is a resident of the issuing state. A foreign bond is issued by a foreign government or a foreign corporation. All of these types of bonds are exposed to default risk.
2.) Identify two ways a corporate bond differs from a government bond. The most important difference between corporate bonds and government bonds is their risk profile. Corporate bonds usually offer a higher yield than government bonds because their credit risk is generally greater. They also differ because a government bond is issued by the federal government while a corporate bond is issued by business firms.
3.) There is a dynamic relationship between interest rates and bond prices - briefly discuss this. The relationship between interest rates and bond prices is inverse. When either of them go up the other goes down. As market interest rates change, a bond's coupon rate which is fixed, becomes more or less attractive to investors. Because of this situation, investors are willing to pay more or less for the bond itself.
4.) Briefly discuss the importance of Bond Ratings, what they are used for and are they helpful to investors. Why or why not? Bond ratings provide these evaluations of a bond