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Indirect Investing and BondsFrom Economics and Personal Finance, Ch. 17-1 and 17-2I. Indirect InvestingYou can lower your investment risk by choosing to invest indirectly. Indirect investing is purchasing mutual funds, joining investment clubs, and other choices instead of owning individual stocks.A. Mutual FundsA mutual fund is a professionally managed group of investments, which allows for constant monitoring of stocks and bonds in the fund, as well as other services. The fund holds a portfolio that may consist of stocks, bonds, or other investments from gold or other commodities, based on a stated set of objectives. For example, an income fund specializes in buying investments that pay a steady rate of return. A growth fund specializes in buying investments that are expected to grow over time. Assets under management (AUM) refers to the total market value of investments managed by a mutual fund, money management firm, hedge fund, portfolio manager, or other financial services companyWith mutual funds, you can manage your investment goals and your risk. Asset allocation is the process of choosing a combination of funds that can be found in different mutual funds. For example, you may choose an allocation that is 25 percent bond fund, 20 percent growth fund, 40 percent income fund, and 15 percent global fund. You can change those percentages by contacting your mutual fund company.B. Corporate BondsCorporations rely on two forms of investing—stocks and bonds. While stocks represent equity or ownership in a company, corporate bonds represent long-term debts of public corporations. This means that investors “lend” money to the corporation so that it can pay for expansion, new technology, innovation, and long-term growth and survival. These bonds are generally issued in multiples of $1,000 and pay a fixed interest rate each year. They also repay the face value (principal) or amount that is borrowed at maturity, a point in the future when the full amount of principal and interest must be repaid. Bonds are considered a fairly safe investment choice because they pay a fixed rate of interest. All corporate bonds are issued with a stated face value, maturity date, and fixed interest rate. Earnings are computed at simple interest rates. For example, a $1,000, 5 percent, ten-year term bond would pay annual interest of $50 ($1,000 × 0.05 = $50). At maturity, the bond would have paid the principal plus interest over the ten years, $1,500. This is computed using the simple interest formula of Interest = Principal × Rate × Time. If the bond pays semi-annual interest, the bondholder receives $25 twice each year.Large, publicly-held corporations are able to issue bonds after they go through an approval process to make sure they are able to repay the debt. Investors in bonds are taking less risk and thus the return is also lower. The major types of public bonds include:C. Municipal and Government BondsIn addition to loaning money to corporations, you can also loan money to the government by purchasing various types of government bonds. Government bonds are issued by the federal, as well as state and local, governments. There are four types of government bonds—municipal, savings, treasury, and agency bonds.Local/State:Municipal bond: issued by state and local governments to raise money for government projects. The minimum investment is usually $5,000, and interest is often exempt from federal, state, and local income taxRevenue bond: municipal bond issued to raise money for a public-works projectU.S. Treasury securities: These include treasury notes, bills, and bonds. These loan obligations of the federal government are kept electronically and the investor receives a regular statement of account. Treasury bill (T-bill) is a short-term security sold in terms ranging from 4 to 52 weeks. T-bills are sold at a discount from face value. For example, you might pay $950 for a $1000 bond.Treasury note (T-note) is a medium-term security, ranging from two to ten years, at a fixed rate of interest determined when the note is sold. The minimum purchase amount is $100.Treasury bond (T-bond) is a long-term security, with a maturity date of 30 years. Having a fixed rate, they pay interest every six months until maturity. Interest rates are usually higher because of the longer term. The minimum purchase amount is $100. Agency bond is a loan of money to a government agency to provide low-cost financing to certain groups of people, such as first-time home buyers or students attending college. Savings bond is a long-term loan to the U.S. government. Some are discount bonds, which are offered at a lower price than its face value. It then grows due to compounding of interest until it reaches its face value.You can buy up to $5,000 worth of savings bonds a year. A Series EE bond is sold at one half its face value. The bond continues to compound interest for a total of 30 years. EE bonds can be purchased in maturity (face) values of $50 to $10,000. An I bond is also a savings bond, but it is sold at face value. It has a fixed interest rate, but that rate also increases with general price increases, or inflation. Investors often choose treasuries because earnings are not taxable by state and local governments; though the returns are lower, the rewards are enhanced because the income is mostly tax-free. For those in higher income brackets, this form of investing can be very attractive. Investing in U.S. government securities is generally said to be risk-free because it doesn’t have a risk of default (the government must pay its debts).D. Features of Bondsright43942000A convertible bond can be exchanged for shares of stock at a preset date or within a preset period of time. For example, assume you purchase a $1,000 corporate bond which is convertible to 50 shares of common stock. You should convert the bond to stock if the common stock is worth $20 or more per share (50 x 20 =$1000). Assuming the common stock was selling for $22 a share, you would then get 50 shares of stock worth $1,100 for your bond that cost you $1,000.A callable bond is a bond where the issuer (corporation) has the right to pay off (call back) a bond at a preset date or within a preset period of time. For example, a ten-year, $1,000, 5 percent bond issued in 2010 might be callable in or after the year 2015. If interest rates have fallen (below 5 percent), the corporation might wish to buy back the bond. When the corporation exercises its right to call a bond, it usually pays a preset amount above face value of the bond. For example, the $1,000 bond may be called for $1,020. ................
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