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Investing in Bonds. Describe bonds and how they are used by corporations and investors. Describe the major characteristics of bonds. Differentiate among the four general types of bonds. Objectives.

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objectives
Describe bonds and how they are used by corporations and investors.

Describe the major characteristics of bonds.

Differentiate among the four general types of bonds.

Objectives
objectives1
Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity.

List the advantages and disadvantages of investing in bonds.

Objectives
descriptive terms for bond features
Descriptive Terms for Bond Features

., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

language of bond investing
Language of Bond Investing
  • Registered and bearer
  • Zero-coupon
  • Callable
  • Warrants
  • Convertibility
language of bond investing1
Language of Bond Investing
  • Indenture
  • Face value, coupon rate, maturity date
  • Secured and unsecured
  • Senior and subordinated
interest income
Interest Income
  • Assume you purchase $1,000 corporate bond issued by AT&T Corporation. The interest rate for this bond is 6.70%. The annual interest is $67 as shown below:

Dollar amount of annual return = Face value x interest rate

= 1,000 x 6.7%

= 1,000 x .067

= $67.00

types of bonds
Types of Bonds
  • Corporate bonds
  • U.S. government securities
    • Treasury bills, notes, and bonds
    • Federal agency issues
  • Municipal Bonds
approximate bond value
Approximate Bond Value
  • Assume you purchase a Verizon Communications bond that pays 5.5% interest based on a face value of $1,000 until maturity in 2017. Also assume new corporate bond issues of comparable quality are currently paying 7%. The approximate market value of your Verizon bond is $786 calculated as follows:

Dollar amount of annual interest = $1,000 x 5.5% = $55

Approximate market value = Dollar amount of annual interest

Comparable interest rate

= $55

7%

= $786

current yield
Current Yield

Current yield = current annual income

current market price

= $55

$786

= 7%

state and local government securities
State and Local Government Securities

Municipal Bonds

General Obligation Bonds

Revenue Bonds

effective yield of a tax free investment
Effective Yield of a Tax-Free Investment
  • Not paying tax effectively increases your rate of return
    • you get to keep all of your profits, instead of only a portion
  • Example: 28% tax bracket, 5% rate of return

= 6.94%

what is the yield or rate of return on a financial investment
What is the Yield or Rate of Return on a Financial Investment?
  • Annualized Percentage Change:

Example: original price=$20/share, current price=$100/share, stock held for 9 years

bond price calculation
Bond Price Calculation

Assume that a bond has a price quote of 84. The actual price for the bond is $840, as calculated below:

Bond price = Face value (usually $1,000) x bond quote

= $1,000 x 84 percent

= $1,000 x .84

= $840

bond ratings
Bond Ratings

A plus sign (“+”) following a rating indicates that it is likely to be upgraded, while a minus sign (“-“) following a rating indicates

that it is likely to be downgraded.

., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

considerations before investing in bonds
Considerations Before Investing in Bonds
  • Susceptibility to certain risks
    • Credit
    • Callability
    • Inflation
    • Interest rate
considerations before investing in bonds1
Considerations Before Investing in Bonds
  • Premiums and discounts
  • Current yield
  • Yield to maturity
  • Tax-equivalent yields
  • When to sell
bond prices bond yields and interest rates
Bond Prices, Bond Yields, and Interest Rates

., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

effective yield of a tax free investment1
Effective Yield of a Tax-Free Investment
  • Not paying tax effectively increases your rate of return
    • you get to keep all of your profits, instead of only a portion
  • Example: 28% tax bracket, 5% rate of return

= 6.94%

advantages of investing in bonds
Advantages of Investing in Bonds
  • Pay higher interest rates than savings
  • Offer safe return of principle
  • Have less volatility than stocks
  • Offer regular income
  • Require smaller initial investment
disadvantages of investing in bonds
Disadvantages of Investing in Bonds
  • No hedge against inflation
  • Can be quite volatile
  • Compounding is almost impossible
  • Subject to investors tax rate
  • Poor marketability
bond characteristics and risk
Bond Characteristics and Risk

., REVIEWBOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .