Transcript Chapter 13 Investing in Bonds

Chapter 13
Investing in Bonds
Chapter 13.1
What is the difference between stocks and
bonds?
 Stocks (aka Equities): Stocks represent
partial ownership of a corporation. If the
corporation does well, its value increases,
and you share in the appreciation.
However, if the corporation goes bankrupt,
you can lose your entire initial investment.
What are bonds?
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Bonds (aka Notes): Bonds represent a loan you make to
a corporation or government.
For example, you can buy a US Treasury bond for $100,
and get a guaranteed 4.75% interest rate for 5-years,
and can expect to get your $100 back at the end of that
5-years. Your risk is repayment of the principal (amount
invested). Because loaning $100 to the U.S. government
is much less risky than loaning $100 to the Brazilian
government, U.S. government bonds pay a much lower
rate of interest ("coupon") for borrowing your money.
Stocks and Bonds .... How do they differ
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Stocks are EQUITY. They represent shares of
ownership in a Corporation. A Stockholder is
actually one of many owners of a Publicly
Owned Corporation. If a Corporation dissolves
for any reason owners of Common Stock (the
main type of stock issued) receive the value of
the sold assets of the Corporation AFTER
everyone else is paid, including the IRS,
Employees, Bonds, Accounts Payable, etc.
Continued
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Bonds are DEBT. They are sold by the
Corporation in order to raise money for various
purposes for use by the company. Bonds offer
an interest rate to the Bondholder for the period
of time that the Bondholder owns the bonds.
Since bonds do not represent ownership, the
bondholder could lose their investment if the
Corporation dissolves, but are paid BEFORE
owners of stock.
Corporate Bonds
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Face value of a bond is the amount the
bondholder will be repaid at maturity. It is
typically $1,000.
Features of Corporate Bonds
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A callable bond is a bond that the issuer
has the right to pay off before its maturity
date.
Types of Corporate Bonds
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Debentures are corporate bonds that are not
backed by collateral but only by the general
credit standing of the company.
A mortgage bond is a corporate bond backed
by specific assets as collateral to assure
repayment of the debt.
A convertible bond is a corporate bond that
can be exchanged, at the owner’s option, for a
specified number of shares of the company’s
stock.
Calculating Current Yield
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Once a bond is issued, the market
determines the current price of the bond.
If the price is higher than 100, the bond is
trading at a premium.
If the price is lower than 100, the bond is
trading at a discount.
Municipal Bonds
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A bond issued by state and local governments is
called a municipal bond (muni).
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A revenue bond is a muni issued to raise money for
a public-works project.
A general obligation bond is a muni backed by the
power of the issuing state or local government to levy
taxes and borrow.
Municipal bonds are exempt from both federal
and state taxes.
Agency Bonds and Zero-Coupon
Bonds
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When you purchase an agency bond, you
are loaning money to one of the
government agencies (FHLMC, FNMA,
TVA).
A zero-coupon bond is a bond that is
sold at a deep discount, makes no interest
payments and is redeemable for its face
value at maturity.
Comparing Taxable and TaxExempt Bonds
Corporate
Bond
Face Value (Principal)
$10,000
Rate of Interest
Amount of Annual Interest
$10,000
6%
$
Tax on Interest Earned (28%)
Net Interest
Municipal
Bond
600
5%
$
168
$
432
500
0
$
500
13.2
How to Buy and Sell Bonds
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You can purchase bonds from a discount
broker, full-service broker or from a bank.
Bonds typically require a minimum of
$1,000.
Evaluating Bonds
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To help investors evaluate the risk level of
bonds, Moody’s and S&P rate bonds on their
level of safety.
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The highest rating is AAA. The lowest rating is D. A
D rating indicates the bond is in default.
Any bond with a Baa or higher in Moody’s, or BBB or
higher is S&P is considered an investment-grade
bond.
A junk bond is a bond that has a low rating, or
no rating at all.
Bonds Top 10
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