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Bonds

Resource

Textbook – page 305-323

- Yahoo Finance - Bond Investing

- Investing in

- Smart

What kind of risk is involved with bonds?

Depending on the type of bond – generally lower risk than stocks. Bondholders are 1st in line after normal creditors (people the company owes money to) to be paid if the company liquidates. Some bonds are risky (junk bonds) but overall bonds offer a state return for the money lent to the company.

What is meant by “coupon”?

The rate of interest paid annually (see bond example – it is 8 ½ %)

What is meant by “maturity date”?

The maturity date is the date the company will pay you back your investment or the face value of the bond.

What is meant by “par value” or face value?

Par value or face value is the dollar amount of the bond that the holder will get back at maturity (generally in values starting at $1000)- it is printed on the bond certificate (see page 307 for sample bond)

Why can the price of a bond be different than the par value of a bond?

Depending on the current interest rates at the time the bond is bought – Example: if the rate on the bond is 8% and the current interest rates on bonds are at 6% the bond can be sold to another investor on the secondary market for more that its face value- it is worth more because the bondholder is guaranteed to receive 8% interest if he hold it. Vice Versa – If the rate on the bond is at 6% and the current rates for new bonds is 8% the bond’s value at market with be less – someone who needs to sell this bond may have to sell it at a discount or less than face value – perhaps at $980 per bond instead of $1000. (see page 311- if clarification is needed)

When does the yield on bonds usually go up?

Yield is the rate of return earned by an investor for holding a bond for a certain period of time. See page 325 for calculation examples. If the current market value of the bond is higher that it’s face value, the current yield decreases. If the current market value is less than the bonds face value, the current yield increases.

What is a bond rating? What is a good/bad bond rating?

Pg 322 – Bonds are rated by 2 different companies called Standard and Poors (S&P) or Moody’s. They are categorized from AAA (highest and best) to D(lowest and worst – more risk)

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Types of bonds

• Corporate bonds- Issues by corporations - sold to finance regular business activities / borrow money / get tax break- types see pgs 307 & 308

• Municipal bonds- Bonds sold by state and local governments to finance projects – buildings, airports, schools, etc

• Treasury bills (T-bills) – sold by government in units of $1000 – safe investment – mature 13/26/52 weeks. Discounted – buy at less than face value. Get face value back at maturity

• Treasury notes (T-notes) – issued in units of $1000, mature between 1 year and 10 years. Higher interest rates than T-bills because your money is tied up longer.

• Treasury bonds (T-bonds)- minimum units of $1000. Mature 10- 20 years

• Zero coupon bonds- provides no interest payment – bought at way below face value – get back the face value at maturity. The difference is your profit.

• Savings bonds – Sold by the government – (series EE bonds) bought at ½ the face value – not a great investments because the interest rate is typically lower and have to wait quite awhile to get the face value amount (12 + years now)

• Junk bonds – very risky - company may have bad credit and you may lose your investment

What are the characteristics of each type of bond? Advantages/disadvantages? See above descriptions.

Compare the yield, liquidity and risk of bonds versus stocks.

If the bond market is doing well – generally stocks are out of favor. Bonds are liquid and can be sold if they have a relatively high interest rate compared to other rates in the economy. They provide a more steady income stream than stocks to and do not have the potential growth rate that stocks do. They are less risky, for the most part than stocks.

Why would you choose to invest in bonds rather than stocks?

Know the rate of income you can expect to receive twice a year. Less risk.

If you were the owner of a business, would you rather sell stock to finance your company or sell bonds? Why?

Opinion – but potential answers: It depends! With stocks, you give up some ownership of the company but can raise capital quickly without the expectation of having to pay dividends / or an investment back to the shareholder. With bonds, you are responsible for being able to pay back bondholders their initial investment at the maturity date of the bond as well as you need to be able to pay the yearly interest due to the bondholders. Good if difficult to sell the company stock – reduces the amount of tax the company pays.

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