finance chapter 10. corporate bonds a corporations written pledge to repay a bondholder the bonds...
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BONDS AND MUTUAL FUNDS
FinanceChapter 10
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CORPORATE AND GOVERNMENT BONDS Corporate Bonds
A corporations written pledge to repay a bondholder
The bonds interest rate, maturity date and face value are listed on the bond
Corporation pays annual interest at the rate specified on the bond (usually semiannually)
Face Value x Interest rate
CORPORATE AND GOVERNMENT BONDS Types of Corporate Bonds
Debentures (Most common) A bond that is backed only by the reputation of the
issuing corporation rather than its assets Buy these because it is believed the corporation is
on solid financial ground Investors expect the company to repay the face
value and make the interest payments. Mortgage Bond (Secured Bond)
A bond backed by the assets of the company Safer than a debenture bond, which means earning
less interest
CORPORATE AND GOVERNMENT BONDS Subordinated Debentures
An unsecured bond that gives you a claim to interest payments and assets of the corporation only after all bondholders have been paid
More risky, higher interest rates Convertible Bonds
A bond that an investor can trade for shares of the corporations common stock.
Interest rates are about 1 to 2 percent lower because of it’s flexibility.
CORPORATE AND GOVERNMENT BONDS Methods Corporations use to repay Bonds
Most bonds are callable: They have a call feature that allows a corporation to buy back
bonds from holders before the maturity date Premiums
An additional amount above face value, if called Sinking Funds
A corporation makes deposits for the purpose of paying back a bond
This means the company will be able to repay its bonds. Serial Bonds
Bonds issued on the same date but which mature on different dates
CORPORATE AND GOVERNMENT BONDS Why Corporations Sell bonds
They sell bonds to raise money when it is difficult or impossible to sell stock
Used to finance regular business activities Why Investors Buy corporate Bonds
Interest Income Registered Bonds – Bond registered in the
owners name by the corporation Only the owner can collect money
CORPORATE AND GOVERNMENT BONDS
Coupon Bonds A bond registered in the owners name for only face value, not for
the interest. Coupons are given to receive the interest, anyone with the coupon
can receive the interest. Bearer Bonds
A bond that is not registered in an investors name Anyone in physical possession of the bonds or their coupons can
collect on them Very few in circulation, but they are no longer issued by
corporations Zero-Coupon Bonds
Bond that does not produce interest payments Sold below face value but is redeemed for full face value at
maturity
CORPORATE AND GOVERNMENT BONDS A Typical Bond Transaction
Purchasing Bonds Primary Markets
You purchase financial securities from an investment banker representing the corporation or government agency that issues them
Secondary Markets You trade bonds with other investors
Corporate Bonds issued by large companies are traded on the New York Bond Exchange and American Bond Exchange
CORPORATE AND GOVERNMENT BONDS Government Bonds and Securities
Federal, State and Local governments issue bonds to raise money they need to operate.
Offer lower interest rates than corporate bonds
Treasury Bills (T-bills) Discounted Securities – Purchase price is lower
than face value Sold in units of $1000
CORPORATE AND GOVERNMENT BONDS
Treasury Notes Issued in $1000 units, with maturity date between 1 – 10 years Interests rates are a little higher than T-bills because investors
must wait longer to get money back Treasury Bonds
No longer issued, but some remain and can be purchased on the secondary market
Series EE Savings Bond Purchase price is ½ of its face value Can be redeemed anytime from 6 months to 30 years You receive the amount you paid plus interest (up to 30 years)
Series I Bonds Inflation indexed bond – Pay a fixed interest rate and a variable
interest rate that adjusts with inflation.
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CORPORATE AND GOVERNMENT BONDS
Bonds Issued by State and Local Governments Municipal Bonds (muni)
A security issued by a state or local government to pay for ongoing activities
Major project: Airports, schools, and highways Classified As:
General Obligation Bonds: Backed by the full faith and credit of the government that issued it
Revenue Bond: Repaid from the income generated by the project it is designed to finance ( Municipal Sports Arenas)
Insured Municipal Bonds If there is a risk of default you can buy these Less risk so less interest
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INVESTING IN BONDS
Bond Price Quotations Percentage of the face value of a bond
$1000 x price quotation (%) You should know this before buying or selling bonds Usually can be found in Barron’s or the Wall Street
Journal Source of Information on Bonds
You should always be aware of the financial stability of the issuer. Always Ask:
Will the bond be repaid at maturity? Will you receive interest payments until maturity?
INVESTING IN BONDS
To help answer the previous questions look at:
Annual Reports Look for signs of financial strength or weaknesses &
ask: Is the firm profitable? Are sales increasing? Are long-term liabilities increasing? How might the company’s current activities and future
plans affect its ability to repay bonds?
The Internet Business Magazines Government Reports and Research
INVESTING IN BONDS
Bond Ratings Each bond is rated by an independent rating company Ratings are based on the financial stability of the issuer Services:
Moody’s Bond Survey Standard and Poor’s Stock and Bond Guide The Internet
Categories (P. 322) Moody’s: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C S&P: AAA, AA, A, BBB, BB, B, CCC, CC, C, D
S&P Municipal Bond Ratings for Municipal bonds that have a maturity date of 3 years or less:
SP-1: Strong ability to pay face value and interest SP-2: Satisfactory ability to pay face value and interest SP-3: Doubtful ability to pay face value and interest
INVESTING IN BONDS
Yield of a Bond Investment To determine the return that a particular bond
may produce, investors calculate and track it’s yield.
Yield The rate of return, usually stated as a percentage,
earned by an investor holding a bond for a certain time period
Current Yield = $ amount of Annual Interest Income / Current Market Value
$1000 Bond @ 7.5% interest, Current market value $960
$1000 x 7.5% = $75 $75/$960 = 7.8% (current yield)
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MUTUAL FUNDS
Investors pool their money to buy stocks, bonds, and other securities based on the selections of professional managers working for an investment company
Why Investors Buy Mutual Funds1. Professional Management2. Diversification
1. Reduce risk because money is spread out into a variety of securities
2. An occasional loss can be offset by a gain in another investment.
MUTUAL FUNDS
Types of Mutual Funds Closed End Funds
A mutual fund with a fixed number of shares that are issued by an investment company when the fund is first organized
Open End Funds A mutual fund with an unlimited number of shares that are
issued and redeemed by an investment company at the investors request
Net Asset Value – Amount that one share of a mutual fund is worth
Services – You have access to many services Payroll Deduction Automatic reinvestment programs Automatic withdrawal programs
MUTUAL FUNDS
Load Funds (“A” funds) A mutual fund for which you pay a commission every
time you buy or sell shares Account Executives offer advice and guidance
No Load Funds A mutual fund with no commission fee
Management Fees and Other Charges Management Fees – Fixed percentage of the funds asset
value Back-end load – charged for withdrawing money from the
fund (to discourage early withdrawals) 12b-1 fee – Investment company charge for marketing
and advertising the mutual fund
MUTUAL FUNDS
Categories of Mutual Funds Stock Mutual Funds
Aggressive Growth Funds
Equity Income Funds Global Stock Funds Growth Funds Growth and Income
Funds Index Funds International Funds Large Cap Funds
Mid Cap Funds Small Cap Funds Micro Cap Funds Regional Funds Sector Funds Utility Funds
MUTUAL FUNDS
Bond Mutual Funds High Yield (Junk)Bond Funds Insured Municipal Bond
Funds Intermediate Corporate
Bond Funds Intermediate U.S. bond
Funds Long Term Corporate Bond
Funds Long Term U.S. Bond Funds Municipal Bond Funds Short Term Corporate Bond
Funds Short Term U.S. Bond Funds
Mixed Mutual Funds Balanced Funds
Money Market Funds
Stock/Bond Blend Funds
Variety Funds
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INVESTING IN MUTUAL FUNDS
Making an Informed Decision Considering Your Financial Goals
Consider several questions for investment goals:
How old are you? What is your family situation? How much risk do you want to take? How much money do you now make? How much money are you likely to make in the
future? Once you know your goals find mutual funds
that match you investment objectives.
INVESTING IN MUTUAL FUNDS
Information on Mutual Funds Main sources of information
Newspaper Financial Publications Quotations Professional Advice Prospectuses Internet Annual Reports
Return on Investments Gain Income in one of three ways
1. Income Dividends – Earnings a fund pays the shareholder2. Capital Gains Distribution – Payments made to
shareholders that result from the sale of securities in the funds portfolio
3. Make a good return by buying shares at a low price and selling them when the price increases (Capital Gain)
INVESTING IN MUTUAL FUNDS
Taxes and Mutual Funds Dividends, capital gain distributions, and capital gains
are all taxable earnings IRS form 1099DIV – shows all capital gains
distributions and income dividends. Guidelines on how mutual fund transactions are taxed:
Income dividends are reported along with all other dividend amounts you have received. They are taxed as regular income
Capital gain distributions are reported on your federal income tax return
Capital gains or losses are reported on your federal income tax return.
INVESTING IN MUTUAL FUNDS
Buying and Selling Mutual Funds Purchase Options
Closed End Funds – Traded through Stock Exchanges Open End Funds – Bought from a brokerage firm or
investment company Regular Account Transaction
Decide how much money to invest and when to invest it Then you buy as many shares as possible
Voluntary Savings Plan Make smaller purchases than minimum required Once you make 1st purchase you commit to making
regular minimum purchases of fund’s shares
INVESTING IN MUTUAL FUNDS
Payroll Deduction Plans Deduct a certain amount of money from each paycheck
to invest in mutual fund Contracted Savings Plans
Require you to make regular purchases of shares over a specific period of time
You will pay penalty fees if you do not make the required purchases
Reinvestment Plans Your income from dividends and capital gain distributions
are automatically reinvested to buy more shares Most allow you to reinvest without paying additional sales
charges or commissions
INVESTING IN MUTUAL FUNDS
Withdrawal Options Closed End Funds – Sell your shares to another investor
anytime you want (Stock Exchange or Over-the-Counter) Open End Funds – Sold to the investment company
If more than $5000: Investment Period Withdrawals – Withdraw a certain amount each
investment period until the fund has been exhausted (Usually 3 months) Investment Period Liquidation – Sell off a certain amount of shares each
investment period Net asset value of shares vary from one period to another
Asset Growth Withdrawal – Withdrawal a prearranged % of your investment’s asset growth (the amount your portfolio has increased in value)
Principal is left untouched Dividend and Distribution Withdrawal – Withdrawal all income from
dividends and capital gains distributions earned during an investment period.
REAL ESTATE
Owning property Direct Investment
Holds legal title to the property he/she has purchased Examples:
Single Family homes Duplexes Apartments Vacation Homes (tax deductions for 2nd home) Commercial Property – Land and buildings that produce rental
income Land
Indirect investment An investment in which a trustee is appointed to hold legal to
the property on behalf of the investor or group of investors
REAL ESTATE
Advantages Hedge against
inflation Easy entry Limited financial
Responsibility (indirect)
Financial Leverage – using borrowed funds for direct investment
Disadvantages Illiquidity Declining property
values Lack of diversification Lack of tax shelter Management
problems (indirect)
OTHER INVESTMENTS
Commodities Precious Metals
Gold, silver, platinum Precious Gems
Rough mineral deposits cut from the earth then cut and shaped into jewels
Diamonds, sapphires, rubies, emeralds
Collectibles Items that are rare in number Buy them and hope to sell them at a profit Art, antiques, rare coins, sports memorabilia Risky because there is such a small market