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1、CHAPTER5Bonds,BondValuation,andInterestRateslotofU.S.bondshavebeenissued,andwemeanalot!AccordingtotheFederalReserve,thereareabout$5.7trillionofoutstandingU.S.ATreasurysecurities,morethan$2.6trillionofmunicipalsecurities,$3.7trillionofcorporatebonds,andmorethan$1.4billionoffo
2、reignbondsheldintheUnitedStates.Notonlyisthedollaramountmind-boggling,butsoisthevariety.Bondscomeinmanyshapesandflavors,andoneevenhasanegativeinterestrate.Howcanabondhaveanegativerate?First,considerabondthatmakesnopaymentsbeforeitcomesdue.Forexample,aninvestormightbuyabondto
3、dayfor$558inexchangeforthepromiseof$1,000in10years.Theinvestorwouldnotreceiveanycashinterestpayments,butthe10-yearincreasefromtheoriginalpurchasepricetothe$1,000repaymentwouldprovidea6%annualreturnontheinvestment.Althoughtherearenoannualcashinterestpayments,thegovernmentstil
4、lallowscorporateissuerstodeductanimputedannualinterestexpensefromtheirtaxableincomebasedonthebond’sannualappreciationinvalue.Thus,thecompanygetsataxdeductioneachyear,eventhoughitisn’tmakingactualinterestpayments.BerkshireHathaway(chairedbyWarrenBuffett)issuedbondswithanegati
5、veinterestratein2002.Technically,Berkshire’sbondscalledfora3%interestpayment,buttheyalsohadanattachedwarrantthatwouldallowaninvestortopurchasesharesofBerkshireHathawaystockatafixedpriceinthefuture.Ifthestockpricerisesabovethespecifiedprice,theninvestorscanprofitbyexercisingt
6、hewarrants.However,BerkshireHathawaydidn’tjustgiveawaythewarrants—itrequiredinvestorstomakeannualinstallmentpaymentsequalto3.75%ofthebond’sfacevalue.Thus,investorsreceivea3%interestpaymentbutmustthenpaya3.75%warrantfee,foranetinterestrateofnegative0.75%.BerkshireHathawaycand
7、eductthe3%interestpaymentfortaxpurposes,butthe3.75%warrantfeeisnottaxable,furtherincreasingBerkshireHathaway’sannualafter-taxcashflow.Thinkabouttheimplicationsoftheseandotherbondsasyoureadthischapter.Source:“FlowofFundsAccountsoftheUnitedStates,SectionL.2,CreditMarketDebtOwe
8、dbyNonfinancialSectors,”http://www.federalreserve.gov/releases/Z1/current/.
