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Key Capital Market Securities

The key capital market securities are bonds and stocks.

Bonds

Bonds are long-term debt securities issued by firms and governments to raise large amounts of long-term funds. Bonds are differentiated by the issuer and can be classified as Treasury bonds, municipal bonds, or corporate bonds.

Treasury Bonds Treasury bonds are issued by the U.S. Treasury as a means of obtaining funds for a long-term period. They normally have maturities from 10 years to 30 years. (As noted previously, the Treasury issues short-term debt

bonds

Long-term securities issued by firms and governments to raise large amounts of long-term funds.

Treasury bonds

Bonds issued by the U.S. Treasury to obtain long-term (10 to 30 years) funds.

securities in the form of Treasury bills. It also issues medium-term debt securities in the form of Treasury notes, which have maturities between 1 and 10 years.) The minimum denomination of Treasury bonds is $1,000, but much larger denominations are more common. The federal government borrows most of its funds by issuing Treasury securities. An active secondary market for Treasury bonds exists, so investors can sell Treasury bonds at any time.

Treasury bonds pay interest (in the form of coupon payments) on a semiannual basis (every 6 months) to the investors who hold them. Investors earn a return from investing in Treasury bonds in the form of these coupon payments and also in the difference between the selling price and the purchase price of the bond.

A Treasury bond with a par value of $1,000,000 and an 8 percent coupon rate pays $80,000 per year, which is divided into $40,000 after the first 6-month period of the year and another $40,000 in the second 6-month period of the year. Interest payments on Treasury bonds received by investors are exempt from state and local income taxes.

Because Treasury bonds are backed by the federal government, the return to an investor who holds them until maturity is known with certainty. The coupon payments are known with certainty, and so is the payment at maturity (the par value). Accordingly, the return that could be earned on a Treasury bond is commonly referred to as a long-term risk-free rate. The annualized return promised on a 10-year bond today serves as the annualized risk-free rate of return over the next 10 years, and the annualized return that is promised on a 20-year Treasury bond serves as the annualized risk-free rate of return over the next 20 years. If investors want to earn a risk-free return over a period that is not available on newly issued Treasury bonds, they can purchase a Treasury bond in the secondary market with a time remaining until maturity that matches their desired investment period.

municipal bonds

Bonds issued by municipalities to support their expenditures.

general obligation bonds

Municipal bonds backed by the municipality's ability to tax.

revenue bonds

Municipal bonds that will be repaid with the funds generated from the project financed with the proceeds of the bond issue.

A debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms.

Municipal Bonds Municipal bonds are bonds issued by municipalities to support their expenditures. They are typically classified into one of two categories. General obligation bonds provide investors with interest and principal payments that are backed by the municipality's ability to tax. Conversely, revenue bonds provide interest and principal payments to investors using funds generated from the project financed with the proceeds of the bond issue. For example, revenue bonds may be issued by a municipality to build a tollway. The proceeds received in the form of tolls would be used to make interest and principal payments to the investors who purchased these bonds. The minimum denomination is $5,000, but larger denominations are more common.

Municipal bonds pay interest on a semiannual basis. The interest paid on municipal bonds is normally exempt from federal income taxes and may even be exempt from state and local income taxes. This very attractive feature of municipal bonds enables municipalities to obtain funds at a lower cost. In other words, investors are willing to accept a lower pre-tax return on municipal bonds, because they tend to be more concerned with the after-tax return.

Municipal bonds have a secondary market, although that market is less active than the secondary market for Treasury bonds. Therefore, municipal bonds are less liquid than Treasury bonds that have a similar term to maturity.

Corporate Bonds Corporate bonds are bonds issued by corporations to finance their investment in long-term assets, such as buildings and machinery. Their standard denomination is $1,000, but other denominations are sometimes issued. The secondary market for corporate bonds is more active for those bonds that were issued in high volume. Because there is less secondary market activity for corporate bonds than there is for Treasury bonds, corporate bonds are less liquid than Treasury bonds with a similar term to maturity. Maturities of corporate bonds typically range between 10 and 30 years, but some recent corporate bond issues have maturities of 50 years or more. For example, both the Coca-Cola Company and Disney recently issued bonds with maturities of 100 years.

 
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