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