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Alan Cring Productions in association with the Emergent Light Studio presents

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the Illinois State Collegiate Compendium, Academic Lectures in Business and Economics.

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This is Business Finance, FIL 240 for spring semester 2024.

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Today's introduction to bonds. Now the lecture today is fair game for the midterm exam.

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We will be reviewing on Monday of next week and then the exam will be on Wednesday.

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Now first of all what I do today is the general outline terminology, some concept behind bonds.

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The mathematical stuff about bonds I will deal with after the spring break.

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And the mathematical information, techniques and skills, they would not be on this midterm exam.

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They're like the last half of chapter 7. So this will be the first half of chapter 7

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that you will be responsible for for the midterm exam.

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And again on Monday I will be spending the day doing the review.

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Now the way the review will work is I will come in and I will tell you what I expect you to know for that exam.

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Now obviously since I'm writing the exam I probably know a lot about what's going to be on it.

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And I will go through step by step. Consider that your study guide.

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You should be here and be getting your notes in order for the midterm exam.

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And then after I finish telling you what I think you should know, I open it up for you to ask me questions about the midterm exam.

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If you say well is this going to be on the exam and it's not, I'll say it's not going to be on the exam.

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This helps also shape it. So this isn't just a watch the lecture kind of session on Monday.

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Now as far as the exam goes you can start getting your prep done.

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You will be allowed a 4x6 note card front and back.

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And you might want to start prepping that, getting that together this weekend.

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You'll have your formula sheet, the financial ratios formula sheet.

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And also of course I do expect you to use Excel for the exam.

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And it should be, if I'm not mistaken, only that present values and future values Excel spreadsheet would be what you would need for the test.

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But we'll get into that a little more, a lot more on Monday.

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So stay tuned for the fun of getting ready for the midterm exam, which is at regular class time.

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I had someone ask me about that.

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But as I said today I will be doing bonds.

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I'm going to clean up a little piece of Chapter 6.

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And if I ask you about this I don't think I will push this too hard.

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And I'll try to lay off too much of the math and get you down to what you would need to do to accomplish finding a forward rate, as we call it, from a yield curve.

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But we'll get to that in a little bit here.

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But first we need to go to have a look at these very complicated markets.

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As you can see it's technically a bare day, but it is volatile as heck.

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If you look at those spark charts for the NASDAQ Dow 30 and Standard Portis 500, they've been down and up and down and up.

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It's kind of odd.

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There's information flowing both ways.

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There's negative information which gets the bears all excited.

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And then there is positive information which brings the bulls back.

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You can look at the Standard Portis 500, great example there.

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Markets started down in the toilet this morning at the opening bell.

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And then the bears started, a bull started fighting back, got it almost up to where it had ended last night.

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And then the bears came back through and now the bulls are charging again.

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Right now the Dow 30 is down 0.11%, which is basically almost nothing.

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And similarly the S&P 500 is down just a piece 5 one hundredths of a percent.

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And even the NASDAQ it was down rather noticeably more than half a percent at one point.

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But now it's been climbing back up too.

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What this means, and from my perspective it doesn't, there's nothing that is so major as far as information goes that the market should be so spooked.

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But I mean it's like every little thing that comes in today is causing a surge of bulls or bears.

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Hard to say what it's all about.

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But over here in the crude, now crude actually touched again up there at that 79.

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Remember I told you that $72 to $79 is that trading range.

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And there you have the crude oil prices.

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They touched 79 again just a little bit through it and then they chickened out and they went back down again.

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So we're down at $78.64 a barrel.

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Now we're up at the upper end of it.

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And that's of course somewhat negative news.

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We get higher gasoline prices a little bit.

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Nothing major.

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But there's also a bright side to this too.

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From what I have been hearing in the scuttlebutt is that the oil prices are going up a little bit.

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It's not because of the conflict in the Middle East or anything like that.

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It's because the economy is improving.

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And when that happens you have more trucks and cars on the road.

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Trucks delivering stuff, cars driving places, and that increases the demand for oil products.

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Diesel for the commercial side, gasoline for the personal side.

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So there you go.

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It might be the case that this crude oil working its way upward, not majorly, but upward a little bit,

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is actually a sign of the recovery.

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We're in a strong recovery and we may be in the first phases of an actual expansion.

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And so this is actually good news for those.

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And gold is fortunately just sort of staying in place.

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It dropped a lot.

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And then when the stock market started getting spooked, it had a little bit of a spike,

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but it's pretty much going nowhere right now, as is silver.

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Working our way over here, here's the 10-year bond.

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Yield is going down on the 10-year bond.

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We're down seven basis points, no, I'm sorry, almost three basis points right now.

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That yield is going down, so the price is going up.

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That means prices are going up.

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So putting it in more, starting at the beginning, we have buy.

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Demand for bonds is increasing.

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The buying causes the price to go up, which causes the yield to go down.

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Now, you need to understand and make sure you've got that in your notes,

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how the mechanism for what we are seeing, how it works.

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Because I could ask you something about that on the midterm exam.

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So make sure that you know that chain of events from the demand or demand side action,

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what it does to the price, and what the inverse consequence is on the yield.

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Make sure you have that down.

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It's pretty much straightforward, and I usually do it as a multiple choice kind of question.

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But anyway, moving over here to the other side of the world, Tokyo last night,

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it finished almost right where it started.

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There was no definitive place that it went because of some good or bad news.

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London, on the other hand, you see how there was that drop until about the midday?

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That would have been negative information coming in,

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pushing down on the prices of the securities on the FTSE 100.

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But you notice once that was gone, no more information.

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You had to think pretty much just drift, just Newton's Law, one of Newton's Laws of Motion.

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You had to have some force to make it do something.

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If there is no force in markets, that's information,

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then it would just sit there looking stupid and float along.

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Looks like there was a little bit of a sell-off there at the very end.

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But we came over here to the U.S.

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and you can see that whatever was making the markets upset over in London

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really was hard on the opening bell here in the United States.

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See how it would just, right off the bat, it was down.

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So there was negative news, but apparently it didn't really spook the markets completely

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because they started to recover, and then it's just been a seesaw back and forth ever since then.

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So there's the stuff about the markets right now.

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And what I want to do, I want to cover one last piece.

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Oops, I didn't mean to do that. I wanted to get to the...

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I can't hold bookmarks here, so...

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I wanted to show you the yield curve.

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This lecture is about bonds.

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And yield curves are nothing but maps of the governments, the treasuries, debt securities.

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Bonds are debt securities.

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And I put this up here, but I won't use the example of this yield curve

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because as I said on Monday, the yield curves right now are really, really weird.

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I think historically there might have been one situation where we had such a long-term decline

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in version of a yield curve, and that would have been around the Great Depression.

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So I won't use this one first for the little lesson I want to show you now.

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But...

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Now for God's sake, don't think too much about what I'm going to do.

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Just follow the steps of the math of it, and I'll explain it as I go along.

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But I'll show you with this.

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Now if you look up here at the headers, and I wish they would let the headers come down with it.

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We usually start talking about this with the one year.

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These are very short-term debt instruments, cash management debt securities of the government.

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They'll borrow money for a month to cover some bills.

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They'll borrow money for two months, three months, four months, six months.

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So that's kind of its own market, what we call a money market.

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We begin this with the one year.

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We'll talk about this.

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Now here if you see right at the yields at the close yesterday.

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For the one year, the yield, the return on a one year bond was 5.03%.

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Now that's just that math calculation, ending price over beginning price divided by minus one to the first power.

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So remember this little thing that I had given you.

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End price over beginning price to the one over the number of years minus one.

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That is a yield. That's a yield.

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Now these are showing in percentages, yields.

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Now notice that underneath the yield are prices, but we don't see those in yield curves.

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We don't even, well we do a little bit talk about them with bonds in general.

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So that 5.03 is simply saying the terminal price divided by what you paid to start it out to the one over one power, that equals 5.03.

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This two year, so a one year would be end price over the beginning price to the one over one year minus one.

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The two year would be the end price of a two year treasury security over its beginning price to the one over two years minus one.

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And the three year would be the end price over the beginning price to the one over three minus one and on and on for the five year, seven year, ten year.

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See there's kind of a little bit of a hidden story behind these though.

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Let me see what...

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What we're saying is that ultimately for the one year is in this case one plus point...

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Well let me do this, let me do this, I don't want to use those yet. Let me say we have a normal yield curve.

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One year, two year and three year.

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Now the one year, let's say that the one year is 4.24%.

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The two year is 4.28% and the three year is 4.34%.

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Let me do that.

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A normal yield curve, that's why I can't use those because they're declining.

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I'll show you what that means in a minute here.

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But let's take a normal yield curve because it'll look a little more sensible.

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So we would have that the one year...

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I just wrote that over there.

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Now...

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So how should I do this? I'm going to do this the fastest way so that you don't see all the complexities inside that would drive you crazy.

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So one plus point 0.420 to the one over one minus one.

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And that would give me the one year yield.

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Now the thing though is that the two year would say that one plus point 0...

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Did I do that? No, I said 2.4, I'm sorry.

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4.24.

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One plus 0.428 to the one over two years minus one.

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Well that one equals 0.04.

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You're saying, well duh.

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But there's something going on here. Would be 0.0428.

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Well there's kind of something going on underneath the surface there.

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If I write it a little bit differently,

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one plus 0.0428 to the one half equals one plus 0.0428.

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Put another way, one plus 0.0428 is actually one plus 0.0428 squared.

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Hidden in here, oops I didn't mean to do that.

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Let me...actual rates.

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The two year is actually one plus 0.0424 times one plus,

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this is the one year rate, times one plus a two year rate.

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You put those together, and that second year is called the forward.

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You put those together and that's actually the 1.428 squared.

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In other words, what we see is a composite yield, like an average.

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The 4.28% is actually two rates, a one year and then the second year put together.

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Now just follow the math of it.

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I can say then, this is called a forward rate.

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It's the one to two year forward rate.

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I could say that one plus that second year forward rate is actually the composite two year rate that we see listed.

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Squared over one plus, so the second year forward rate is just the composite rate,

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1.0428, the one we see, squared divided by one plus 0.0424 minus one.

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In other words, the two year rate is actually the one year one rate times the two year rate.

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Put together, we see that two year rate that is listed in the tables.

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Bear with me. I'll show you what I mean. Watch.

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Let me pull this up here and show you.

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If I do 1.0428 squared divided by 1.0424 minus one, I get the hidden rate, what we call the forward rate.

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The forward rate comes out to be 4.32%.

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So what's really happening is we're saying that one plus 0.0424 times one plus 0.0432 is why we actually see

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1.0428, one plus 0.0428 to the second power.

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It's actually a composite of the one year rate plus the two year forward rate. Watch.

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If I did, there will be a little round here. 1.0424 times 1.0432.

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Now if I take 1.0428 squared, I should get about the same number.

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No, I don't. I did that wrong. Yeah, I do. See? They're the same number.

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So in other words, when we see a yield on something like a two year, three year, five year, whatever,

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it's actually the composite of a chain of one year rates that takes us out that far.

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That's what happens when I take the square root of that. Square root.

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Nope, I didn't want to do that. I take the second square root.

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Why am I doing that wrong? Second square root. There we go.

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Of the answer I got from before. Oh, I can't do that. Quit.

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Oh, well, I can't do it because I just deleted what I had done there.

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But the square root of that 1.08 whatever was 1.0428.

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Now the next thing that I can do here, and I'm going to write a formula for this.

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For the three year rate, I would know that one plus the first year's rate, 0.0424,

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times one plus the forward rate, 0.0432, times the forward rate on the third year,

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should be the same as the composite 1 plus 0.0434 to the third power.

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So in other words, for a two year rate, for the two year, you would want to do

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one plus the two year rate squared over one plus the one year rate.

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For the three year, you would want to do one plus the three year rate

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to the third power over one plus the one year, times one plus the two year forward.

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This is what I'm going to do here.

218
00:26:32,000 --> 00:26:44,000
One plus the forward rate for three years would be one plus 0.0434 to the third power,

219
00:26:44,000 --> 00:27:02,000
divided by one plus 0.0424, times one plus what you had gotten in the second step, 3.2.

220
00:27:02,000 --> 00:27:07,000
And that should give you one plus the three year forward rate.

221
00:27:07,000 --> 00:27:31,000
And if I do that, I would take 1.0434, 1.04304, 3.4, to the third power,

222
00:27:31,000 --> 00:27:43,000
divided by, and then I pull this off, I open parentheses for the whole thing,

223
00:27:43,000 --> 00:28:06,000
1.0424, 1.0424, times 1.0432, 1.0432.

224
00:28:06,000 --> 00:28:11,000
Close the parentheses and subtract that one off.

225
00:28:11,000 --> 00:28:24,000
So the three year forward rate, the rate from year two to year three, is 4.47%.

226
00:28:24,000 --> 00:28:32,000
So, if we look instead of at composite rates, we look at forward rates,

227
00:28:32,000 --> 00:28:35,000
the one year is the one year.

228
00:28:35,000 --> 00:28:48,000
The two year, the interest rate for year one to year two is 4.32.

229
00:28:48,000 --> 00:29:06,000
And the three year is 4.46, 4.47.

230
00:29:06,000 --> 00:29:15,000
These are the forward rates.

231
00:29:15,000 --> 00:29:18,000
They are not the same as what you see up there.

232
00:29:18,000 --> 00:29:26,000
They are year by year, each year, year by year, what the rates would have to be

233
00:29:26,000 --> 00:29:36,000
to create the composite rate that is the overall ending price divided by beginning price.

234
00:29:36,000 --> 00:29:44,000
It's hidden, it's a hidden part of the data, but it tells us what we are actually seeing.

235
00:29:44,000 --> 00:29:50,000
Let me do really quickly the two year forward rate from the table

236
00:29:50,000 --> 00:29:54,000
and show you what it would look like using the formula.

237
00:29:54,000 --> 00:29:59,000
And I'm also going to create an Excel sheet just for forward rates for use,

238
00:29:59,000 --> 00:30:01,000
in case you're kind of panicking.

239
00:30:01,000 --> 00:30:10,000
So, for the two year, what I would have to do is I would take the second year

240
00:30:10,000 --> 00:30:16,000
of second year composite rate, clear this out,

241
00:30:16,000 --> 00:30:20,000
take the second year composite rate and square it.

242
00:30:20,000 --> 00:30:22,000
That's what you would do for the two year.

243
00:30:22,000 --> 00:30:34,000
I'll take 1 plus.0470, so that's 1.0470.

244
00:30:34,000 --> 00:30:36,000
And I would square that.

245
00:30:36,000 --> 00:30:49,000
And then I would divide it by the one year rate, 1.0503.

246
00:30:49,000 --> 00:30:51,000
And then I would subtract 1.

247
00:30:51,000 --> 00:30:57,000
Now I'm finding the two year forward rate.

248
00:30:57,000 --> 00:31:01,000
What did I do wrong there?

249
00:31:01,000 --> 00:31:04,000
Oh, minus 1, I forgot to put the 1.

250
00:31:04,000 --> 00:31:08,000
Okay.

251
00:31:08,000 --> 00:31:12,000
So it's 4.37%.

252
00:31:12,000 --> 00:31:18,000
So what this is saying is that for the coming year, year one,

253
00:31:18,000 --> 00:31:24,000
we have the forward rate is the yield rate, 5.03.

254
00:31:24,000 --> 00:31:31,000
But in year one to two, the forward rate is, we would say,

255
00:31:31,000 --> 00:31:37,000
the market thinks it's going to be 4.37%.

256
00:31:37,000 --> 00:31:47,000
So in other words, the forward rate here is less than the composite two year rate of 4.70%.

257
00:31:47,000 --> 00:31:49,000
I could even do one more here.

258
00:31:49,000 --> 00:32:03,000
I could take the three year, 1.0450 to the third power,

259
00:32:03,000 --> 00:32:21,000
divided by the one year, 1.0503 times the two year forward rate,

260
00:32:21,000 --> 00:32:32,000
which we found was 4.37, so that would be 1.0437.

261
00:32:32,000 --> 00:32:44,000
Close the parenthesis, minus the 1, so the three year rate is only 4.10%.

262
00:32:44,000 --> 00:32:51,000
So in other words, the market actually thinks that for the coming year,

263
00:32:51,000 --> 00:33:00,000
the yield on a one year T-bell is going to be 5.03%.

264
00:33:00,000 --> 00:33:11,000
But in year two, the interest rate is going to fall to 4.37%.

265
00:33:11,000 --> 00:33:22,000
And in the third year, year two to three, the actual interest rate for just that year is going to be 4.1%.

266
00:33:22,000 --> 00:33:24,000
That's what this is telling us.

267
00:33:24,000 --> 00:33:29,000
Finding the forward rates tells us not what the overall picture will be.

268
00:33:29,000 --> 00:33:37,000
It's telling us what the picture of the interest rate will be in each of those years.

269
00:33:37,000 --> 00:33:44,000
That's where it's useful to us, because that's what we would really want to do if we're planning ahead.

270
00:33:44,000 --> 00:33:47,000
Well, next year we're going to do this project.

271
00:33:47,000 --> 00:33:52,000
You wouldn't look at the 4.70% as your base for starting your calculations.

272
00:33:52,000 --> 00:33:57,000
You would work with the 4.37% as your base.

273
00:33:57,000 --> 00:34:01,000
If you're going to do this project and borrow the money in the second year.

274
00:34:01,000 --> 00:34:05,000
Now, if you're going to put a project off until the third year,

275
00:34:05,000 --> 00:34:13,000
then I would say that you should be planning for a base risk-free rate of about 4.1%.

276
00:34:13,000 --> 00:34:16,000
That's the use of this.

277
00:34:16,000 --> 00:34:19,000
Now, I'll put this into an Excel sheet for you,

278
00:34:19,000 --> 00:34:23,000
so that you don't have to go through the pain in the ass of these calculations.

279
00:34:23,000 --> 00:34:26,000
But once you've done it a few times with Excel or whatever,

280
00:34:26,000 --> 00:34:32,000
it begins to kind of make sense that what we see in yields

281
00:34:32,000 --> 00:34:40,000
is actually just the composite of what was thought about for each period overall.

282
00:34:40,000 --> 00:34:47,000
And the forward rates tell us how that composite was actually created

283
00:34:47,000 --> 00:34:51,000
by the individual interest rates of each year going forward.

284
00:34:51,000 --> 00:34:54,000
That's what that's all about.

285
00:34:54,000 --> 00:35:00,000
It's a side movement, and they cover a page or two in the textbook.

286
00:35:00,000 --> 00:35:07,000
And I give it to you now, but for now, I will have an Excel sheet up for you

287
00:35:07,000 --> 00:35:10,000
probably late tonight or tomorrow morning,

288
00:35:10,000 --> 00:35:13,000
so that you can do these forward rate calculations on your own

289
00:35:13,000 --> 00:35:20,000
without going through this mess of trying to show you why we do what we do to get them.

290
00:35:20,000 --> 00:35:24,000
But anyway, you put that aside for a while,

291
00:35:24,000 --> 00:35:29,000
put it in the back of your memory, because I won't ask for forward rates on any exam,

292
00:35:29,000 --> 00:35:32,000
but they could be in your homework.

293
00:35:32,000 --> 00:35:34,000
So I cover it.

294
00:35:34,000 --> 00:35:41,000
But for now, we're going to go on to something else.

295
00:35:41,000 --> 00:35:44,000
As a matter of fact, I can kill this now.

296
00:35:44,000 --> 00:35:46,000
Now, this is all memory work.

297
00:35:46,000 --> 00:35:53,000
This is definitions and concepts, so it's fair game for the midterm,

298
00:35:53,000 --> 00:35:57,000
but there's no math in what I'm going to do for you right now.

299
00:35:57,000 --> 00:36:02,000
And in some cases, I go into a little more detail than the book does,

300
00:36:02,000 --> 00:36:05,000
just to tell you what the background story is.

301
00:36:05,000 --> 00:36:07,000
This is bonds.

302
00:36:07,000 --> 00:36:12,000
Now, the first thing to mention about bonds is that the bond market

303
00:36:12,000 --> 00:36:17,000
is about 10 times the size of the stock market.

304
00:36:17,000 --> 00:36:21,000
It is a vast ocean of securities.

305
00:36:21,000 --> 00:36:27,000
Now, remember, when I say, you, madam, issued a bond to me,

306
00:36:27,000 --> 00:36:32,000
that is the same thing as saying that you borrowed money from me.

307
00:36:32,000 --> 00:36:39,000
The bond is what you sell to me, and in exchange for the bond, I give you money.

308
00:36:39,000 --> 00:36:41,000
That's what a bond is.

309
00:36:41,000 --> 00:36:50,000
It's just an agreement to pay back a certain amount of money that's borrowed.

310
00:36:50,000 --> 00:36:55,000
Now, I use the term bond generically, as we all do.

311
00:36:55,000 --> 00:37:01,000
A bond could be, I mean, remember the technical distinction.

312
00:37:01,000 --> 00:37:03,000
A note is less than a year.

313
00:37:03,000 --> 00:37:06,000
I'm sorry, a bill is less than a year.

314
00:37:06,000 --> 00:37:15,000
A note is 1, 2, 7, 10, or 15 years, depending on whom you're talking to.

315
00:37:15,000 --> 00:37:24,000
And a bond is technically something that's very long-term, 20 years or so.

316
00:37:24,000 --> 00:37:28,000
But like I said, that's a little bit slippery.

317
00:37:28,000 --> 00:37:33,000
Notes, we used to say a note was anywhere from 1 to 7 years,

318
00:37:33,000 --> 00:37:39,000
but a bond was anywhere longer than that.

319
00:37:39,000 --> 00:37:41,000
But it's a little bit fuzzy.

320
00:37:41,000 --> 00:37:45,000
But bond is just the generic term for a debt instrument.

321
00:37:45,000 --> 00:37:52,000
Now, about the size of the bond market and why,

322
00:37:52,000 --> 00:37:56,000
if something is 10 times the size of the stock market,

323
00:37:56,000 --> 00:38:00,000
why do we talk about stocks all the time?

324
00:38:00,000 --> 00:38:09,000
We talk about this giant 800-pound gorilla that's wandering around in the monkey cage.

325
00:38:09,000 --> 00:38:12,000
It has to do with, and I've said this before,

326
00:38:12,000 --> 00:38:16,000
but I'll emphasize it here and get a little bit deeper into it.

327
00:38:16,000 --> 00:38:20,000
It has to do with the fact that bonds are boring.

328
00:38:20,000 --> 00:38:24,000
Bonds are not exciting at all.

329
00:38:24,000 --> 00:38:28,000
Bonds don't go up and down and up and down and bounce around,

330
00:38:28,000 --> 00:38:30,000
and you don't see the talking heads,

331
00:38:30,000 --> 00:38:33,000
boy, oh boy, these bonds really did a lot today.

332
00:38:33,000 --> 00:38:35,000
They moved four cents.

333
00:38:35,000 --> 00:38:38,000
Boy, I was exhausted after watching that.

334
00:38:38,000 --> 00:38:42,000
They don't go up and down much at all.

335
00:38:42,000 --> 00:38:45,000
The reason is kind of simple.

336
00:38:45,000 --> 00:38:48,000
Well, there are two reasons.

337
00:38:48,000 --> 00:38:55,000
The first reason is that stocks, you are playing, to some extent,

338
00:38:55,000 --> 00:39:02,000
you're in a casino type of environment, ups and downs, wins and losses.

339
00:39:02,000 --> 00:39:09,000
There is no telling where it will be tomorrow.

340
00:39:09,000 --> 00:39:15,000
You could lose everything you invested if a stock goes to the toilet,

341
00:39:15,000 --> 00:39:20,000
or you could become a multimillionaire in a few weeks.

342
00:39:20,000 --> 00:39:23,000
Literally, they can go anywhere.

343
00:39:23,000 --> 00:39:27,000
Bonds can't go, well, I shouldn't say they can't,

344
00:39:27,000 --> 00:39:35,000
but they rarely would go very far simply because stocks, you're all at risk.

345
00:39:35,000 --> 00:39:40,000
When you buy that stock, you've got no guarantee whatsoever

346
00:39:40,000 --> 00:39:42,000
about what's going to come out of that.

347
00:39:42,000 --> 00:39:47,000
Like I said, you could lose it all tomorrow, or you could become quite wealthy.

348
00:39:47,000 --> 00:39:52,000
With bonds, that's not going to happen because, first of all,

349
00:39:52,000 --> 00:39:59,000
bonds have the prior claim to cash flows of a corporation.

350
00:39:59,000 --> 00:40:05,000
They have to get, the bondholders have to get their money.

351
00:40:05,000 --> 00:40:08,000
You cannot give the stockholders a dividend.

352
00:40:08,000 --> 00:40:12,000
You cannot plow money back into the company on behalf of the shareholders

353
00:40:12,000 --> 00:40:22,000
until you have satisfied the current obligations to your bondholders.

354
00:40:22,000 --> 00:40:25,000
That's just the reality of it.

355
00:40:25,000 --> 00:40:30,000
In my own company, I have one outstanding debt.

356
00:40:30,000 --> 00:40:38,000
It is a type of bond, and the lender was a bank.

357
00:40:38,000 --> 00:40:44,000
I have to pay them my interest payments every month.

358
00:40:44,000 --> 00:40:46,000
I have to pay it.

359
00:40:46,000 --> 00:40:54,000
Whether or not I, the owner, get to eat or not, I have to pay the bondholders.

360
00:40:54,000 --> 00:41:03,000
So in other words, with any bond, there's an anchor, the principal, the balance.

361
00:41:03,000 --> 00:41:06,000
That has to be paid.

362
00:41:06,000 --> 00:41:09,000
So they don't whipsaw up and down.

363
00:41:09,000 --> 00:41:18,000
They stay relatively near where the obligation is as far as the cost, the price,

364
00:41:18,000 --> 00:41:20,000
or whatever you want to say.

365
00:41:20,000 --> 00:41:27,000
They're going to be very close to that through the life of the bond.

366
00:41:27,000 --> 00:41:31,000
And so they can't go way up and way down.

367
00:41:31,000 --> 00:41:34,000
There is a fixed obligation involved.

368
00:41:34,000 --> 00:41:40,000
So if I lend you money, madam, I know that it's going to be that much money

369
00:41:40,000 --> 00:41:44,000
that I have to give you back, and you know it too.

370
00:41:44,000 --> 00:41:49,000
So there's not a lot of volatility in the value of that at all.

371
00:41:49,000 --> 00:42:03,000
And the second reason is simply that the bonds are held under a very firm agreement.

372
00:42:03,000 --> 00:42:07,000
It's called the bond indenture agreement.

373
00:42:07,000 --> 00:42:18,000
The bond indenture agreement.

374
00:42:18,000 --> 00:42:26,000
And I'll get into that in just a minute here.

375
00:42:26,000 --> 00:42:34,000
They are a formal kind of contract, and it is established at the very beginning.

376
00:42:34,000 --> 00:42:42,000
And that bond indenture agreement has lots of language in it

377
00:42:42,000 --> 00:42:48,000
that carries the weight of legal obligations.

378
00:42:48,000 --> 00:42:54,000
Unlike stocks, a bond is fixed by this giant contract.

379
00:42:54,000 --> 00:43:01,000
I had actually never seen one of these in the first maybe 20 years that I taught.

380
00:43:01,000 --> 00:43:05,000
I talked about them, and finally I was on a trip to New York City

381
00:43:05,000 --> 00:43:10,000
to visit a friend who worked for an investment banker.

382
00:43:10,000 --> 00:43:14,000
And I just had asked him before I went out there, I said,

383
00:43:14,000 --> 00:43:18,000
do you have a bond indenture agreement so I can actually see one of these contracts

384
00:43:18,000 --> 00:43:21,000
between the lenders and the company?

385
00:43:21,000 --> 00:43:25,000
And he said, yeah, I got one, and he showed it to me, let me look at it.

386
00:43:25,000 --> 00:43:27,000
The thing was like a book.

387
00:43:27,000 --> 00:43:32,000
It's a contract between the lenders and the borrower.

388
00:43:32,000 --> 00:43:34,000
And it is detailed.

389
00:43:34,000 --> 00:43:36,000
I didn't even realize how detailed it is.

390
00:43:36,000 --> 00:43:40,000
But just to give you an idea of how detailed.

391
00:43:40,000 --> 00:43:45,000
Now, remember, an investment banker, they don't just deal with stocks.

392
00:43:45,000 --> 00:43:46,000
They'll deal with bonds.

393
00:43:46,000 --> 00:43:52,000
I came to you, or did I come to you or did you come to me?

394
00:43:52,000 --> 00:43:54,000
I sold the bond to you.

395
00:43:54,000 --> 00:43:56,000
Okay, and I am the investment banker.

396
00:43:56,000 --> 00:43:58,000
I'm the IB.

397
00:43:58,000 --> 00:43:59,000
Now, I'll make a syndicate.

398
00:43:59,000 --> 00:44:02,000
You want to borrow $100 million.

399
00:44:02,000 --> 00:44:09,000
Okay, so essentially you are seeking $100 million loan from me.

400
00:44:09,000 --> 00:44:12,000
Well, I'm going to divvy that up in a syndicate.

401
00:44:12,000 --> 00:44:14,000
I'm not going to do the whole thing myself.

402
00:44:14,000 --> 00:44:16,000
I'm not stupid.

403
00:44:16,000 --> 00:44:19,000
Okay, so we are going to go into a negotiation.

404
00:44:19,000 --> 00:44:25,000
The negotiation will be how much, obviously, and the interest rate.

405
00:44:25,000 --> 00:44:28,000
That's called the coupon.

406
00:44:28,000 --> 00:44:31,000
And there will be a lot of other things.

407
00:44:31,000 --> 00:44:45,000
These are called the covenants of the bond, in that agreement.

408
00:44:45,000 --> 00:45:00,000
Now, there will be how much, among other things, how much, what interest rate.

409
00:45:00,000 --> 00:45:07,000
Now, in our world, we call that the coupon or the coupon rate.

410
00:45:07,000 --> 00:45:14,000
Now, we usually don't fix that until right before the loan, because interest rates could be moving around.

411
00:45:14,000 --> 00:45:18,000
And if we worked that out, like, a month before, interest rates could do something.

412
00:45:18,000 --> 00:45:31,000
So we're going to work it out so that interest rate is very close to what the prevailing interest rate is for a loan of this risk level.

413
00:45:31,000 --> 00:45:37,000
And then there are going to be how long.

414
00:45:37,000 --> 00:45:40,000
That would have to do with the maturity date.

415
00:45:40,000 --> 00:45:48,000
When in the future do I owe this back?

416
00:45:48,000 --> 00:45:50,000
And then there are going to be others.

417
00:45:50,000 --> 00:45:59,000
Among them is one that I will mention here, the bond trustee.

418
00:45:59,000 --> 00:46:07,000
This is a person, a law firm, maybe an accounting firm.

419
00:46:07,000 --> 00:46:21,000
It is an entity that actually oversees the interests of the bondholders during the life of the loan.

420
00:46:21,000 --> 00:46:30,000
So, for example, going back to you, just to continue this.

421
00:46:30,000 --> 00:46:35,000
Now, I have appointed this gentleman as the bond trustee.

422
00:46:35,000 --> 00:46:40,000
He represents my interests as the lender.

423
00:46:40,000 --> 00:46:44,000
You say, well, you know, we want to be on the edge of the field.

424
00:46:44,000 --> 00:46:52,000
We're going to take on this new, really risky project, and boy, we think it will fly and we'll make a lot of money.

425
00:46:52,000 --> 00:46:55,000
And he's going to say, no, you're not.

426
00:46:55,000 --> 00:46:57,000
And you're going to say, well, what do you mean, asshole?

427
00:46:57,000 --> 00:46:58,000
Of course we are.

428
00:46:58,000 --> 00:47:11,000
And he says, no, you're not, because you see, his interest is in making sure that EBIT is above the interest expense for the period.

429
00:47:11,000 --> 00:47:20,000
In other words, he doesn't want, I don't want you to take on a project that could go way up in revenues, great for the shareholders,

430
00:47:20,000 --> 00:47:26,000
or it could cream your company, in which case I would be out my money.

431
00:47:26,000 --> 00:47:28,000
He's not going to let you do that.

432
00:47:28,000 --> 00:47:38,000
He's going to say, no, because you are putting my, what you owe me at risk by doing something like this.

433
00:47:38,000 --> 00:47:46,000
It would be like, for example, that you sort of take out a car loan with me, and then you say, yeah, I'm going to take this car to the NASCAR circuit.

434
00:47:46,000 --> 00:47:48,000
And I'll say, the hell you say.

435
00:47:48,000 --> 00:47:53,000
No, you're not, because my loan is backed by that car I lent you.

436
00:47:53,000 --> 00:47:56,000
You're not going to do that.

437
00:47:56,000 --> 00:48:06,000
Matter of fact, if you look at a lot of home loans, the mortgage agreement, there are covenants that say what you cannot do with that house.

438
00:48:06,000 --> 00:48:13,000
You decided, for example, that you, sir, were going to buy a house, and you were going to turn it into a brothel.

439
00:48:13,000 --> 00:48:21,000
Yes, it will be popular, especially in this part of the country, where nothing happens that's exciting.

440
00:48:21,000 --> 00:48:32,000
But the thing, though, is that I, as a lender, am going to say, no, you are not, because I get nothing out of that.

441
00:48:32,000 --> 00:48:35,000
But you could end up in bankruptcy.

442
00:48:35,000 --> 00:48:37,000
You could be raided by the police.

443
00:48:37,000 --> 00:48:43,000
You could have a mosh pit some night, and they burn down the damn place because they're all so happy.

444
00:48:43,000 --> 00:48:45,000
No, you're not going to do that.

445
00:48:45,000 --> 00:48:52,000
Now, understand that when you borrow money for a loan, that's a bond.

446
00:48:52,000 --> 00:48:54,000
You're issuing a bond to a bank.

447
00:48:54,000 --> 00:48:55,000
That's what you're doing.

448
00:48:55,000 --> 00:48:57,000
You're issuing a bond.

449
00:48:57,000 --> 00:49:02,000
The price of the bond is what I lend you.

450
00:49:02,000 --> 00:49:05,000
So you're issuing a security.

451
00:49:05,000 --> 00:49:12,000
When you borrow for a car, you're issuing a note, a five, six-year note.

452
00:49:12,000 --> 00:49:22,000
And I, as the buyer of that note, the price I'm paying is what I am lending you so you can have that car.

453
00:49:22,000 --> 00:49:25,000
So the bond trustee makes sure that no...

454
00:49:25,000 --> 00:49:30,000
Oh, and also, well, we feel like we're going to give out a really great dividend this year.

455
00:49:30,000 --> 00:49:32,000
And the bond trustee says, no, you're not.

456
00:49:32,000 --> 00:49:38,000
You're going to put that money into retained earnings, because this year, yeah, it was great.

457
00:49:38,000 --> 00:49:40,000
You want to give candy to your shareholders.

458
00:49:40,000 --> 00:49:41,000
We get it.

459
00:49:41,000 --> 00:49:43,000
But what happens if next year sucks?

460
00:49:43,000 --> 00:49:49,000
We want to make sure that you have enough money in the bank to cover our interest.

461
00:49:49,000 --> 00:49:55,000
That's why the bond trustee is important, that it goes to that prior claim.

462
00:49:55,000 --> 00:49:56,000
They're going to cover.

463
00:49:56,000 --> 00:49:58,000
They're going to protect themselves.

464
00:49:58,000 --> 00:50:04,000
So they want to make sure that your earnings for interest and taxes is high enough,

465
00:50:04,000 --> 00:50:10,000
well enough away from what you owe in interest expense that we're okay.

466
00:50:10,000 --> 00:50:17,000
In other words, the times interest earned is well enough above one so that we don't have to worry

467
00:50:17,000 --> 00:50:23,000
about whether you're going to have a problem taking care of your payments.

468
00:50:23,000 --> 00:50:27,000
Now, the next thing, what did I write there?

469
00:50:27,000 --> 00:50:29,000
Okay.

470
00:50:29,000 --> 00:50:36,000
Consumer loans versus corporate and government loans.

471
00:50:36,000 --> 00:50:38,000
They're different animals.

472
00:50:38,000 --> 00:50:44,000
With consumer loans, the payments, you know, you calculate with Excel those payments.

473
00:50:44,000 --> 00:50:53,000
There is, those payments are designed to pay the interest for the period on the balance of the loan

474
00:50:53,000 --> 00:50:58,000
and some extra to pay down the balance.

475
00:50:58,000 --> 00:51:05,000
In other words, the payments service the loan, pay the interest it's due for the period,

476
00:51:05,000 --> 00:51:13,000
and they amortize the loan, service and amortize the loan, both.

477
00:51:13,000 --> 00:51:17,000
Corporate and government debt doesn't work like that.

478
00:51:17,000 --> 00:51:26,000
In corporate and government debt, the payments are only the interest, the coupon.

479
00:51:26,000 --> 00:51:33,000
So in other words, let's say that that $10 million, we had, we talked about that one.

480
00:51:33,000 --> 00:51:44,000
It's a 20-year, 8%, 20-40-4.

481
00:51:44,000 --> 00:51:53,000
And it's for $10 million.

482
00:51:53,000 --> 00:52:13,000
What this says is every year for 20 years, you will pay the lenders, the bondholders,

483
00:52:13,000 --> 00:52:21,000
8% times $10 million.

484
00:52:21,000 --> 00:52:36,000
And then at the end of 20 years, at year 20, 2024 to 2044, at the end of year 20,

485
00:52:36,000 --> 00:52:44,000
you will pay one last coupon payment of $800,000.

486
00:52:44,000 --> 00:52:48,000
Is that right? No.

487
00:52:48,000 --> 00:52:56,000
You'll pay one last of those, plus you will pay back the $10 million.

488
00:52:56,000 --> 00:53:01,000
So in other words, the loan is not amortizing.

489
00:53:01,000 --> 00:53:05,000
That's the way corporate and government debt works.

490
00:53:05,000 --> 00:53:11,000
All the borrower pays is the interest every year.

491
00:53:11,000 --> 00:53:17,000
And then at the end, it pays its last interest payment and it pays off the loan.

492
00:53:17,000 --> 00:53:20,000
The whole shebang that it borrowed.

493
00:53:20,000 --> 00:53:22,000
Good times.

494
00:53:22,000 --> 00:53:30,000
Now in reality, the bond indenture agreement is going to have some mechanism

495
00:53:30,000 --> 00:53:39,000
where the company is putting away enough money every year so that the $10 million is already there

496
00:53:39,000 --> 00:53:44,000
and the company is not, oh my God, it's year 20, we owe $10 million.

497
00:53:44,000 --> 00:53:51,000
There are two general ways that that is taken care of.

498
00:53:51,000 --> 00:53:53,000
One is what's called a sinking fund,

499
00:53:53,000 --> 00:54:00,000
where the company has to put like maybe a million dollars in the bank every year for the first 10 years

500
00:54:00,000 --> 00:54:11,000
so that the bondholders know that that $10 million and even more is there when the company has to pay off the loan.

501
00:54:11,000 --> 00:54:13,000
Sinking funds are very common.

502
00:54:13,000 --> 00:54:16,000
There's another trick that is done too.

503
00:54:16,000 --> 00:54:20,000
I don't think it is as common, but maybe it is,

504
00:54:20,000 --> 00:54:27,000
where the company actually buys back part of the bonds every year

505
00:54:27,000 --> 00:54:31,000
so that by the time 20 years has made it,

506
00:54:31,000 --> 00:54:39,000
they just buy back what's left of the bonds that are still out there in the open market.

507
00:54:39,000 --> 00:54:42,000
That's another way that it's often done.

508
00:54:42,000 --> 00:54:44,000
Like I said, I don't know whether it's more common.

509
00:54:44,000 --> 00:54:48,000
Sinking funds used to be the way.

510
00:54:48,000 --> 00:54:52,000
A long time ago, I would not have even brought up this other way.

511
00:54:52,000 --> 00:54:56,000
It wouldn't have occurred to me, but it does seem to have some popularity now.

512
00:54:56,000 --> 00:55:04,000
In other words, you're kind of paying off the loan as you go along, but it's in chunks.

513
00:55:04,000 --> 00:55:09,000
You're just going out there into the open market, me the borrower,

514
00:55:09,000 --> 00:55:14,000
well, in this case, she the borrower, is just going out there.

515
00:55:14,000 --> 00:55:19,000
Maybe next year you buy $2 million of the bond issue,

516
00:55:19,000 --> 00:55:22,000
and the next year you buy $1 million of the bond issue.

517
00:55:22,000 --> 00:55:27,000
And so by the time 20 years comes, there's just a little bit of the original issue

518
00:55:27,000 --> 00:55:31,000
still floating around out there, and you buy that up.

519
00:55:31,000 --> 00:55:35,000
That's another way that it's done.

520
00:55:35,000 --> 00:55:39,000
Okay.

521
00:55:39,000 --> 00:55:45,000
That's kind of the outline of how it works.

522
00:55:45,000 --> 00:55:53,000
Now, let me go through some of the technicalities of it.

523
00:55:53,000 --> 00:56:06,000
Whenever we talk about bonds, we scale them all to a face value.

524
00:56:06,000 --> 00:56:10,000
In other words, a principal amount.

525
00:56:10,000 --> 00:56:19,000
The face value, the FV, if you will, is $1,000.

526
00:56:19,000 --> 00:56:28,000
In other words, if it's a $10 million issue, we just make it $1,000 per bond for what?

527
00:56:28,000 --> 00:56:31,000
100,000 bonds?

528
00:56:31,000 --> 00:56:34,000
100,000?

529
00:56:34,000 --> 00:56:35,000
Yeah.

530
00:56:35,000 --> 00:56:37,000
No.

531
00:56:37,000 --> 00:56:39,000
For 10,000 bonds.

532
00:56:39,000 --> 00:56:44,000
We just make it face value as is always $1,000.

533
00:56:44,000 --> 00:56:53,000
I don't even put that in to any kind of a question I would give you.

534
00:56:53,000 --> 00:56:57,000
You just know that it's $1,000.

535
00:56:57,000 --> 00:57:08,000
The problem is, long, long, long ago, in the 19th century,

536
00:57:08,000 --> 00:57:15,000
at the beginning of every day, before the markets opened on Wall Street,

537
00:57:15,000 --> 00:57:20,000
all these brokers and traders and dealers would be moving down the street,

538
00:57:20,000 --> 00:57:23,000
trying to find some place to buy some coffee.

539
00:57:23,000 --> 00:57:28,000
They would go by the printing houses, which at the beginning of every day,

540
00:57:28,000 --> 00:57:35,000
just after sunrise, they would print out these big, broad sheets that listed the closing prices

541
00:57:35,000 --> 00:57:41,000
of all the stocks and closings on all the bonds.

542
00:57:41,000 --> 00:57:46,000
But they had to make the columns very narrow to get everything in the broadsheet.

543
00:57:46,000 --> 00:57:54,000
And this thing became the convention that we never quoted a price.

544
00:57:54,000 --> 00:57:58,000
We quoted on the hundred.

545
00:57:58,000 --> 00:58:08,000
So in other words, if the actual price of a bond was $992,

546
00:58:08,000 --> 00:58:18,000
we would quote 99.20, or in our parlance, 99.20.

547
00:58:18,000 --> 00:58:28,000
And that has stayed to this day, that bonds, what you see is a quote, not a price.

548
00:58:28,000 --> 00:58:32,000
I have kind of a funny story.

549
00:58:32,000 --> 00:58:38,000
Many years ago, this old kind of rich guy, he was an optometrist.

550
00:58:38,000 --> 00:58:40,000
He thought he was a genius in the stock market.

551
00:58:40,000 --> 00:58:44,000
Before people had, many people had computers and all that.

552
00:58:44,000 --> 00:58:53,000
He had one, he had some stock market software, and he decided he was going to buy some bonds.

553
00:58:53,000 --> 00:58:58,000
And so he put in an order to buy these bonds.

554
00:58:58,000 --> 00:59:07,000
And they were at, he saw the quote, 99.20, and he said, buy 10 of them.

555
00:59:07,000 --> 00:59:15,000
And when they came back with the confirmation, he was out close to $10,000.

556
00:59:15,000 --> 00:59:19,000
He just had a fit. He was threatening to kill people.

557
00:59:19,000 --> 00:59:24,000
They're charging me 10 times what the price was.

558
00:59:24,000 --> 00:59:32,000
And he called me on the phone, and he's cussing and swearing, said, Frank, that's a quote.

559
00:59:32,000 --> 00:59:34,000
It's a tenth of the price.

560
00:59:34,000 --> 00:59:36,000
Well, who invented that?

561
00:59:36,000 --> 00:59:39,000
Some people like 200 years ago, you moron.

562
00:59:39,000 --> 00:59:41,000
He didn't know.

563
00:59:41,000 --> 00:59:47,000
So be careful when you look at those prices, what look like prices, on the ticker symbols and all that,

564
00:59:47,000 --> 00:59:52,000
and on your software, your TD Ameritrade, thinkorswim, or your Robinhood.

565
00:59:52,000 --> 00:59:55,000
Those are quotes. Those aren't bond prices.

566
00:59:55,000 --> 00:59:59,000
So always be careful of that.

567
00:59:59,000 --> 01:00:04,000
So you might see me, if it looks like it's a small number, that's a quote.

568
01:00:04,000 --> 01:00:06,000
And I would say, quoting.

569
01:00:06,000 --> 01:00:10,000
That should not have a dollar sign on it because it isn't a dollar.

570
01:00:10,000 --> 01:00:14,000
Now, interestingly, Excel is weird.

571
01:00:14,000 --> 01:00:20,000
I'm going to walk you through a couple of templates for bonds.

572
01:00:20,000 --> 01:00:25,000
And on one side, you put in the price to get one thing.

573
01:00:25,000 --> 01:00:31,000
On the other side, you have to put in the quote to get what you want.

574
01:00:31,000 --> 01:00:38,000
And I have no idea who at Excel thought this, Microsoft, thought this up.

575
01:00:38,000 --> 01:00:44,000
But it's really strange that one side, you would put $992.

576
01:00:44,000 --> 01:00:51,000
But in this other template part, you would have to put 99.2.

577
01:00:51,000 --> 01:00:55,000
I have no idea where that came from.

578
01:00:55,000 --> 01:01:01,000
Okay, now a little term here, PAR.

579
01:01:01,000 --> 01:01:09,000
PAR is $1,000 or 100 on the 100.

580
01:01:09,000 --> 01:01:23,000
It is the exact price at which the loan was originally made, we hope.

581
01:01:23,000 --> 01:01:29,000
So, see this bond right here, this $992 one?

582
01:01:29,000 --> 01:01:39,000
We would say that that bond is selling at a discount to PAR.

583
01:01:39,000 --> 01:01:57,000
On the other hand, if I saw a $1,015, we would say that that is selling at a premium to PAR.

584
01:01:57,000 --> 01:02:00,000
That's our terminology.

585
01:02:00,000 --> 01:02:05,000
Now, why would a bond sell at a discount or a premium to a thousand?

586
01:02:05,000 --> 01:02:12,000
You're paying the interest along the way, so this isn't affecting the principal, which is the thousand.

587
01:02:12,000 --> 01:02:17,000
Well, you see, the next part of this is the coupon.

588
01:02:17,000 --> 01:02:25,000
Or you might hear it called the coupon rate.

589
01:02:25,000 --> 01:02:32,000
This is the interest rate that was agreed upon to start the loan.

590
01:02:32,000 --> 01:02:35,000
That's the coupon.

591
01:02:35,000 --> 01:02:43,000
When you borrow money at an APR of 6.19%, technically that's the coupon.

592
01:02:43,000 --> 01:02:50,000
That's the interest you must pay every month in the case of a bond.

593
01:02:50,000 --> 01:02:54,000
Or in the case of a car loan or a mortgage loan.

594
01:02:54,000 --> 01:02:58,000
It is fixed at the beginning.

595
01:02:58,000 --> 01:03:03,000
So what happens if interest rates in the economy go somewhere else?

596
01:03:03,000 --> 01:03:09,000
Let's say that I have a coupon rate of, let's say, 8%, like I had here.

597
01:03:09,000 --> 01:03:13,000
Well, what happens if interest rates go up?

598
01:03:13,000 --> 01:03:24,000
You're stuck with 8%, so that's why the price that you could sell the bond at, if you want to dump it,

599
01:03:24,000 --> 01:03:30,000
would go down because it's not as valuable.

600
01:03:30,000 --> 01:03:37,000
Whoever buys that is going to get 8% when interest rates are higher than that.

601
01:03:37,000 --> 01:03:44,000
So people were going to buy bonds, I'm not buying that until I can get it at a deal.

602
01:03:44,000 --> 01:03:56,000
On the other hand, so in other words, at a discount, coupon would be less than the market rate.

603
01:03:56,000 --> 01:04:01,000
The market rate is what we call the yield.

604
01:04:01,000 --> 01:04:10,000
However, suppose that you've got an 8% bond and interest rates in the economy drop.

605
01:04:10,000 --> 01:04:17,000
Oh, you've got candy. So people are going to want to get a hold of that.

606
01:04:17,000 --> 01:04:22,000
Demand will go up and the price will go up.

607
01:04:22,000 --> 01:04:31,000
So in other words, this would happen if the coupon becomes more than the market rate.

608
01:04:31,000 --> 01:04:44,000
That is, the yield.

609
01:04:44,000 --> 01:04:52,000
This sounds more complicated than it is. It really just boils down to some basic ideas, basic concepts.

610
01:04:52,000 --> 01:05:02,000
But, maturity date.

611
01:05:02,000 --> 01:05:16,000
When it's all over, like that 2044, that has a maturity date probably exactly 20 years after the date of the loan.

612
01:05:16,000 --> 01:05:24,000
You can have maturity rates, I mean, one year, two year, three year, five year, seven year, ten, 20, 30.

613
01:05:24,000 --> 01:05:31,000
There are even some maturity dates that are 50 years in the future.

614
01:05:31,000 --> 01:05:36,000
There are some that are even longer, like 100 years.

615
01:05:36,000 --> 01:05:41,000
If you've got a very, very long term project.

616
01:05:41,000 --> 01:05:53,000
Like for example, companies that would be borrowing to start the process of mining asteroids.

617
01:05:53,000 --> 01:06:04,000
Those bonds would have to be awfully long before they start, because the project wouldn't even start paying hardly at all for a long, long time.

618
01:06:04,000 --> 01:06:12,000
So you can have bonds that are very, very long. I believe some countries have like 50 or 100 year bonds.

619
01:06:12,000 --> 01:06:22,000
Because the government, the treasury, needs to borrow money for that long for some monster, very long term project.

620
01:06:22,000 --> 01:06:29,000
And all that good stuff.

621
01:06:29,000 --> 01:06:38,000
Now, one more term, which is the word term.

622
01:06:38,000 --> 01:06:55,000
How long does the bond have before maturity?

623
01:06:55,000 --> 01:07:05,000
You see that bond, if I issue a bond this year, the maturity is 2044.

624
01:07:05,000 --> 01:07:12,000
But we can talk about that bond, well, what happens if we're in the year 2030?

625
01:07:12,000 --> 01:07:20,000
Well, the maturity date is 2024, but that bond has only 14 years left.

626
01:07:20,000 --> 01:07:31,000
So in other words, the maturity is a fixed number. The term gets smaller and smaller as you go along.

627
01:07:31,000 --> 01:07:39,000
So that's the term of a bond. And actually, I hate it, hate it, hate it.

628
01:07:39,000 --> 01:07:46,000
Technically, to do the math of bonds, all you need is the maturity date.

629
01:07:46,000 --> 01:07:56,000
Technically, you just need the term of a bond. Because a bond's price and yield are wholly, are dependent upon the term,

630
01:07:56,000 --> 01:08:09,000
not the date of maturity. It drives me crazy that Excel insists that you put in when the bond started.

631
01:08:09,000 --> 01:08:17,000
Instead of just saying, here's the term of the bond. But I made it in the template, so that's not hard to do.

632
01:08:17,000 --> 01:08:23,000
Anyway, that's some background on it. Now, let me tell you about bonds.

633
01:08:23,000 --> 01:08:34,000
Treasury bonds, those are bonds issued by the government. And when you buy a treasury bond, you're lending the government money.

634
01:08:34,000 --> 01:08:41,000
The government is constantly selling treasury bonds and bills and notes.

635
01:08:41,000 --> 01:08:50,000
They are an auction, the treasury auction might have $10 billion of treasury bills, short-term borrowings.

636
01:08:50,000 --> 01:08:56,000
Might have another $30 billion of treasury notes. Those are one to seven year.

637
01:08:56,000 --> 01:09:08,000
And then it might have $25 billion in treasury bonds. And it's an auction market. It used to be a physical location, now it's all electronic.

638
01:09:08,000 --> 01:09:17,000
And these lenders just go right up to the table and they buy at the auction. They buy at the auction.

639
01:09:17,000 --> 01:09:25,000
And those lenders, they can be insurance, life insurance companies, they could be trust funds, they could be corporate borrowers.

640
01:09:25,000 --> 01:09:28,000
Corporate lenders have got a pile of money.

641
01:09:28,000 --> 01:09:36,000
Countries, whole nations go to our auctions and buy our treasury debt. In other words, they lend us money.

642
01:09:36,000 --> 01:09:45,000
China is a huge lender. They buy up vast numbers of our treasury bonds.

643
01:09:45,000 --> 01:09:51,000
So we have the treasuries. That's one type of bond.

644
01:09:51,000 --> 01:10:00,000
Those are government issued, backed by the full faith and credit of the United States government.

645
01:10:00,000 --> 01:10:06,000
They're very safe, so they have very low coupon rates. Very safe.

646
01:10:06,000 --> 01:10:12,000
Now there's one, the book doesn't mention this one, but it's kind of an important one.

647
01:10:12,000 --> 01:10:18,000
There is what is called agency, what are called agency bonds.

648
01:10:18,000 --> 01:10:25,000
Agency bonds are bonds that are issued by agencies of the United States government.

649
01:10:25,000 --> 01:10:28,000
They're not technically treasuries.

650
01:10:28,000 --> 01:10:34,000
And they're technically not even backed by the full faith and credit of the United States.

651
01:10:34,000 --> 01:10:40,000
Everyone assumes that they kind of are, but they actually technically aren't.

652
01:10:40,000 --> 01:10:46,000
Now an agency like the Tennessee Valley Authority is an agency. It issues its own bonds.

653
01:10:46,000 --> 01:10:51,000
You could buy TVA bonds. There are a lot of different agencies.

654
01:10:51,000 --> 01:11:06,000
And interestingly enough, when we see the national debt, we don't see, all we see is how much outstanding debt, bonds, notes and bills, the treasury has.

655
01:11:06,000 --> 01:11:11,000
Very rarely do you see one that includes the agency debt.

656
01:11:11,000 --> 01:11:21,000
Now if I remember the timeline right, the agency debt surged for quite a few years.

657
01:11:21,000 --> 01:11:27,000
I mean like 15, 20 percent of the whole United States debt.

658
01:11:27,000 --> 01:11:32,000
But it declined quite a bit during the Obama administration.

659
01:11:32,000 --> 01:11:39,000
And then it came back up, I might be wrong about this, but it came back up under the Trump administration.

660
01:11:39,000 --> 01:11:44,000
And I think it has gone back down during the Biden administration.

661
01:11:44,000 --> 01:11:51,000
But it's still debt. You might say, well I'd like to invest, lend money that's pretty safe.

662
01:11:51,000 --> 01:11:59,000
Well you can't beat that. Even if it's agency debt, it'll pay a little more in a coupon than straight treasury debt.

663
01:11:59,000 --> 01:12:05,000
Just because we're not sure if there's no default risk.

664
01:12:05,000 --> 01:12:14,000
Another one, the next one that I would bring up are municipals.

665
01:12:14,000 --> 01:12:23,000
Munis. These are issued by sovereign entities below the federal level.

666
01:12:23,000 --> 01:12:26,000
States will issue their municipals.

667
01:12:26,000 --> 01:12:38,000
Now the one thing about municipals is if I buy a Muni, the interest payments I get are not taxed at the federal level.

668
01:12:38,000 --> 01:12:48,000
That's kind of cool. And so their coupons are lower because they're tax free.

669
01:12:48,000 --> 01:12:56,000
But the problem is of course only the richest in the top tax brackets would get the full impact of that tax free status.

670
01:12:56,000 --> 01:13:02,000
Because they'd have the most to gain or not lose from not having to pay tax on.

671
01:13:02,000 --> 01:13:07,000
Now Munis, they could be like for sewers and water.

672
01:13:07,000 --> 01:13:14,000
You're putting in those so a city could put out a bond issue to pay for that.

673
01:13:14,000 --> 01:13:20,000
School districts have them because they want money.

674
01:13:20,000 --> 01:13:24,000
I mean they're out there. And then there are a couple other types.

675
01:13:24,000 --> 01:13:44,000
I may mention them on Monday. But that's all I have for you today. I thank you.