If a company goes bankrupt, the bondholders get paid before the sharehold-

ers. In some bankruptcies, the bondholders take over the business, leaving
the current shareholders with nothing.
How bonds trade
Bonds often trade as single bonds, with a face value of $1000, although some
brokers will only take on minimum orders of ten bonds. They do not trade as
frequently as stocks do because most bond investors are looking for steady
income, so they hold their bonds until maturity. Bonds have less risk than
stocks, so they show less price volatility. The value of a bond is mostly deter-
mined by the level of interest rates in the economy. As rates go up, bond
prices go down; when rates go down, bond prices go up. Bond prices are also
affected by how likely the loan is to be repaid. If traders dont think that the
bond issuer will pay up, then the bond price will fall.
Generally speaking, only corporate and municipal bonds have repayment
risk. Its possible that the U.S. government could default, but thats unlikely
as long as it can print money. Most international government bonds have sim-
ilarly low default risk, but some countries have defaulted. The most notable
was Russia, which refused to print money to repay its debts in the summer of
1998. This caused huge turmoil in the worlds financial markets, including the
collapse of a major hedge fund, Long-Term Capital Management.
Investment banks and the Federal government sell new bonds directly to
investors. After they are issued, bonds are said to trade in the secondary
market some are listed, some trade over-the-counter, meaning dealers
trade them amongst themselves rather than over an organized exchange.
A bond price quote looks like this:
3 3/4 Mar 07 n 99:28 99:29
This is a U.S. Treasury note maturing in March 2007 carrying an interest rate
of 3.75 per cent. Similar to stocks, the numbers right after the n (for note)
list the bid and ask. The first number is the bid, and its the price that the
dealer will buy the bond from you if you are selling. The second number is
the ask, and it is the price that the dealer will charge you if you are buying.
The difference is the spread, and thats the dealers profit.
But wait, theres more: corporate bonds trade in eighths of a percentage
point, and Treasury bonds trade in 32nds. The bid of 99:28 means that the
bonds bid price is 99 28/32 per cent of the face value of $1000, or $998.75.
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Chapter 3: Signing Up for Asset Classes
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