Week three's assigned reading focuses on the concept of bond as financial and investment instrument. I can't

Fantastic news! We've Found the answer you've been seeking!

Question:

Week three's assigned reading focuses on the concept of bond as financial and investment instrument. I can't emphasize enough the role of a well functioning bond (debt/credit) market in a prosperous capital system. While not getting the flashy treatment of the media as equity (stock) does, the bond market is several times larger than the equity market and in the U.S. this year alone close to a trillion in new bond, just for the investment grade market (larger high quality companies), will be issued. A company may do one IPO in their lifetime, but they will tap the debt markets using bonds over and over again, perhaps as often as once or twice a year. So, needless to say, the credit and bond markets manage the flow of the largest quantity of capital in the world, employ more people and in some shape and form will be around for a long period of time, as debt has been around since biblical times and companies will continue to access debt to expand and continue operations, like they have done for centuries.

Step one for this week, take the time to review chapter 5 in detail so you can grasp the basic fundamentals of a bond and how it functions mathematically. The big picture is simple, a bond is a contract where you hand over cash to the company (a loan) where in most cases they agree to pay interest every six months (coupon), followed by the return of the initial loan amount at the end of the term. Of course, the bond market has evolved into a mix of different products with different features, but the basic concept of a loan in return for interest is still the same.

Now, since the Federal Reserve initiated the aggressive mix of monetary policies during the financial crisis of 2008-2009, commonly referred to as QE (quantitative easing) to jump start the U.S. economy, interest rates have been driven lower (more money pumped into the system, more money and lower interest rates, lower interest rates more people and corporations borrow and more economic activity) and as you will read in chapter 5, lower interest rates lead to higher prices for bonds and higher return for bond investors. Consequently, for the last few years bond investors have benefited from significant returns. But of course, during the last few years, with the economy stabilizing, the Federal Reserve has started slowly but surely raising the benchmark rate, thereby fueling higher bond rates and cost of borrowing across the markets. And then, came the current crisis, where equity markets collapsed and the credit markets temporarily froze, enticing the Federal Reserve to once again aggressively move in to stabilize the bond markets with rates cut to zero and several other programs to pump money into the system and maintain order in bond and credit markets.

This lead us to the participation discussion topic of the week. Armed with your basic understanding of bonds and bond markets, your task is, mostly based on external research (outside your book and the material provided in this class) to explain what is the best bond investment strategy going forward, considering the storm of falling rates during the last months as a Federal Reserve that was on path to raise rates and an economy thrown in turmoil, there is a wealth of information about the bond markets and what is happening in the news right now. Keep in mind that you can't simply say "I would invest in bonds or I will not invest in bonds". Similar to many bond fund managers, just like myself, you have no option. You have been given billions of dollars in money from investors to invest in the bond market and you can't sit idle, you must go out there and invest it in the bond market. But at the same time, you must be aware of the fundamental trends in the bond market and not blindly invest, but have an appropriate strategy that is customized to the anticipated trends. What I'm looking for here is not much of an individual bond picks, "I'm going to invest in IBM bond or I will invest in Amazon bond" but what bond features should you be looking for that best fits the current bond environment. The big clue here is "duration" and "credit risk", so get to know those concepts from your book and any other research material.

Again, read chapter 5 and get to know the product. Start doing some research on the current state of the bond markets and see what the trends are. Focus on the big picture items such as QE, duration and the big unknowns, the continuation of the QE effort in Europe and what is happening in the bond markets right now. Based on what you find, tell me what's the bond investment strategy you would develop and what features will you focus on when creating the bond portfolio.