Finance: Capital Markets, Financial Management, and Investment Management

CHAPTER 19

Bond Portfolio Management

Bonds are debt instruments that are issued by a wide range of entities throughout the world. Unlike the investor in common stock who hopes to share in the good fortunes of a corporation, through increased dividends and price appreciation in the stock’s price, an investor in a bond has agreed to accept a fixed contractual interest rate. The features that may be included in a bond affect its performance when market interest rates and their risk characteristics change.

In this chapter, we explain the types of bonds, their investment characteristics, the types of risks to which investors are exposed and how some risks can be quantified, and bond portfolio strategies. The valuation of a bond, just like the valuation of any financial asset, is explained in Chapter 7.

SECTORS OF THE BOND MARKET

The U.S. bond market is the largest bond market in the world. There are many ways to classify the bond markets. One way is in terms of the taxability of the interest at the federal income tax level. In the United States, most securities issued by state and local governments and by entities that they establish, referred to as municipal bonds or municipal securities, are exempt from federal income taxation. While there are reasons why some issuers of municipal bonds will issue taxable bonds, the municipal bond market is generally viewed as the market for tax-exempt securities. As such, the primary attraction to investors is this tax feature.

The largest part ...