1. Bonds and Mutual Funds Chapter 10

2. Corporate and Government Bonds Section 10.1 Describe the characteristics of corporate bonds Describe the characteristics of corporate bonds Identify the reasons corporations sell bonds Identify the reasons corporations sell bonds Explain why investors buy corporate bonds Explain why investors buy corporate bonds Discuss the reasons governments issue bonds Discuss the reasons governments issue bonds Identify the types of government bonds Identify the types of government bonds

3. What is Corporate Bond? When purchased, basically loaning money to corporation When purchased, basically loaning money to corporation Maturity date – date when paid is repaid, 1 to 30 years normally Maturity date – date when paid is repaid, 1 to 30 years normally Less than 5 short term, 5 to 15 intermediate, more than 15 long-term Less than 5 short term, 5 to 15 intermediate, more than 15 long-term Face value - $ amount bondholder will receive at maturity Face value - $ amount bondholder will receive at maturity Typically $1,000, as high as $50,000 Typically $1,000, as high as $50,000 Get paid interest semiannually until maturity Get paid interest semiannually until maturity

4. Types of Corporate Bonds Debentures Debentures Mortgage bonds Mortgage bonds Subordinate debentures Subordinate debentures Convertible bonds Convertible bonds

5. Debentures Most corporate bonds are this kind Most corporate bonds are this kind Backed by reputation of company, not assets Backed by reputation of company, not assets Investors buy on belief that company is on solid financial ground Investors buy on belief that company is on solid financial ground Investors expect full repayment and regular interest payments Investors expect full repayment and regular interest payments

6. Mortgage Bonds Often referred to as a “secure bond” Often referred to as a “secure bond” Backed by company assets like real estate or equipment Backed by company assets like real estate or equipment Equipment and assets can be sold to repay bond if needed Equipment and assets can be sold to repay bond if needed Safer than debenture, but pays less interest because risk is lower Safer than debenture, but pays less interest because risk is lower

7. Subordinated Debentures Unsecured bond, only paid after all other bonds paid Unsecured bond, only paid after all other bonds paid Considered more risky, but higher interest payments Considered more risky, but higher interest payments

8. Convertible Bonds Can be traded for shares of common stock Can be traded for shares of common stock 1 to 2% lower than rates on other bonds 1 to 2% lower than rates on other bonds As the company’s stock value increases, so does the convertible bonds value As the company’s stock value increases, so does the convertible bonds value Investors choose not to convert to stock because bonds are safer than stock and pay interest income Investors choose not to convert to stock because bonds are safer than stock and pay interest income

9. Repaying Bonds Most bonds are callable, meaning corporations can buy back bonds before maturity which would save company having to pay interest income Most bonds are callable, meaning corporations can buy back bonds before maturity which would save company having to pay interest income Get money to call bonds by Get money to call bonds by Selling stock Selling stock Using profits Using profits Selling new bonds at lower interest rate Selling new bonds at lower interest rate

10. Methods to Repay Bonds Premiums – paid if bonds called back early, additional amount above face value Premiums – paid if bonds called back early, additional amount above face value Sinking Funds – corporation makes deposits to fund to pay back bond issue Sinking Funds – corporation makes deposits to fund to pay back bond issue Serial Bonds – issued at same time, but mature on different dates so company buys back a chunk of bonds at a time Serial Bonds – issued at same time, but mature on different dates so company buys back a chunk of bonds at a time

11. Why Corporations Sell Bonds When it is hard to sell stock When it is hard to sell stock Finance business activities Finance business activities Can reduce tax liabilities (bond interest is tax deductible) Can reduce tax liabilities (bond interest is tax deductible)

12. Responsibility to Bondholders Bondholders must be repaid, stockholders do not Bondholders must be repaid, stockholders do not Interest must be paid on bonds, can choose to pay on stocks Interest must be paid on bonds, can choose to pay on stocks In cases of bankruptcy, bondholders claims paid first In cases of bankruptcy, bondholders claims paid first

13. Why Invest in Bonds? Stocks result in greater profits than bonds, so why invest in them? Stocks result in greater profits than bonds, so why invest in them? Safer than stock Safer than stock Provide interest income Provide interest income May increase in value May increase in value Face value repaid at maturity Face value repaid at maturity

14. Interest Income Registered Bonds – only owner can collect interest Registered Bonds – only owner can collect interest Coupon Bonds – has detachable coupons that any holder can collect interest, only owner can collect face value Coupon Bonds – has detachable coupons that any holder can collect interest, only owner can collect face value Bearer Bonds – no name, so whoever has physical possession of bonds can collect (no longer issued) Bearer Bonds – no name, so whoever has physical possession of bonds can collect (no longer issued) Zero-Coupon Bonds – no interest payments made, but sold below face value Zero-Coupon Bonds – no interest payments made, but sold below face value

15. Market Value of Bond Overall economy interest rates affect market value Overall economy interest rates affect market value Bond sold at 7.5%, then interest rates fall, the bond is worth more money on market Bond sold at 7.5%, then interest rates fall, the bond is worth more money on market Bond sold at 7.5%, then interest rates rise, the bond is worth less money on market Bond sold at 7.5%, then interest rates rise, the bond is worth less money on market Financial conditions, as well as supply and demand, may affect market value Financial conditions, as well as supply and demand, may affect market value Selling at discount – selling for less than face value Selling at discount – selling for less than face value Selling at premium – selling more than face value Selling at premium – selling more than face value

16. Maturity Repayment Two choices after bond purchase Two choices after bond purchase Keep it to maturity Keep it to maturity Sell it at anytime Sell it at anytime Value of bond tied to corporation’s ability to repay it Value of bond tied to corporation’s ability to repay it

17. Where Can You Purchase? Full-service brokerage Full-service brokerage Discount brokerage Discount brokerage Online Online Primary market – directly from company Primary market – directly from company Secondary market – NYBE, ABE Secondary market – NYBE, ABE

18. Government Bonds and Securities Treasury Bills Treasury Bills Treasury Notes Treasury Notes Treasury Bonds Treasury Bonds US Savings Bonds US Savings Bonds Keep in mind you must pay federal income tax on interest from these, however you are exempt from state and local taxes Keep in mind you must pay federal income tax on interest from these, however you are exempt from state and local taxes

19. Treasury Bills Sold in units of 1,000 Sold in units of 1,000 Mature in 4, 13, 26, or 52 weeks Mature in 4, 13, 26, or 52 weeks Discounted security – actual purchase price less than maturity value Discounted security – actual purchase price less than maturity value Receive the full face value at maturity Receive the full face value at maturity

20. Treasury Notes Issued in $1,000 units Issued in $1,000 units Maturity one to ten years Maturity one to ten years Interest rates slightly higher than t-bills b/c investors wait longer to get money Interest rates slightly higher than t-bills b/c investors wait longer to get money

21. Treasury Bonds No longer issued, but can be bought on secondary market No longer issued, but can be bought on secondary market Issued in $1,000, with 10 to 30 years maturity Issued in $1,000, with 10 to 30 years maturity Interest rates usually highest among T- bills, and treasury notes Interest rates usually highest among T- bills, and treasury notes

22. Series EE Savings Bonds Purchase price half of face value Purchase price half of face value Can redeem 6 months to 30 years of purchase Can redeem 6 months to 30 years of purchase Can receive interest up to 30 years Can receive interest up to 30 years Not taxed by local or state govt., and no federal until bond is cashed Not taxed by local or state govt., and no federal until bond is cashed

23. Series I Savings Bond Pay fixed interest rate lower than traditional bonds Pay fixed interest rate lower than traditional bonds Also pay a variable interest rate that increases with inflation Also pay a variable interest rate that increases with inflation Recalculated twice a year Recalculated twice a year

24. State and Local Govt. Bonds Municipal bond Municipal bond Issued by state or local govt. to pay for ongoing activities or major projects Issued by state or local govt. to pay for ongoing activities or major projects Classified as: Classified as: General obligation bonds – backed by full faith and credit of govt. that issued it General obligation bonds – backed by full faith and credit of govt. that issued it Revenue bonds – repaid by income generated by project its designed to finance Revenue bonds – repaid by income generated by project its designed to finance Govts. have defaulted on rare occasions Govts. have defaulted on rare occasions

25. Section 10.2 Section 10.2

26. Determining Bond Investment Value Bond Price Quotations Bond Price Quotations Sources of Information on Bonds Sources of Information on Bonds Bond Ratings Bond Ratings Yield of Bond Investment Yield of Bond Investment

27. Bond Price Quotation In metropolitan newspapers, The Wall Street Journal, and Barron’s In metropolitan newspapers, The Wall Street Journal, and Barron’s Bond quotation is a % of face value (usually $1000) Bond quotation is a % of face value (usually $1000) If price quotation is 84, current market value is $840 ($1000 * 84% = $840) If price quotation is 84, current market value is $840 ($1000 * 84% = $840)

28. Sources of Information on Bonds Need to know financial stability of issuer: Need to know financial stability of issuer: Will it be repaid at maturity? Will it be repaid at maturity? Will you receive interest payments until maturity? Will you receive interest payments until maturity? Annual reports Annual reports Internet Internet Business magazines Business magazines Govt. reports and research Govt. reports and research

29. Bond Ratings Companies that assign ratings on quality and risk based on financial stability of issuer Companies that assign ratings on quality and risk based on financial stability of issuer Moody’s Bond Survey Moody’s Bond Survey Standard & Poor’s Stock and Bond Guide Standard & Poor’s Stock and Bond Guide Types of ratings Types of ratingsratings

30. Yield of a Bond Investment Current Yield = $ of Annual Interest Income Current Market Value Current Yield = $ of Annual Interest Income Current Market Value Can compute yield and compare to other securities Can compute yield and compare to other securities Higher the yield the better Higher the yield the better

31. Section 10.3

32. What are mutual funds? Investment alternative where investors pool money together Investment alternative where investors pool money together Buy stocks, bonds, and other securities Buy stocks, bonds, and other securities Professionals managers at investment companies make selections Professionals managers at investment companies make selections Allows for a diverse portfolio with people with limited resources Allows for a diverse portfolio with people with limited resources

33. Why buy mutual funds? Professional management – be sure to monitor and review funds regularly Professional management – be sure to monitor and review funds regularly Diversification – reduces risk, some may lose, but some may gain Diversification – reduces risk, some may lose, but some may gain 1970 – 361 mutual funds 1970 – 361 mutual funds 2003 – 8,300 mutual funds 2003 – 8,300 mutual funds

34. Types of Mutual Funds Closed-end funds Closed-end funds Open-end funds Open-end funds Load funds Load funds No-load funds No-load funds Management fees and other charges Management fees and other charges

35. Closed-End Funds About 6% of all mutual funds About 6% of all mutual funds Investment company only issues fixed number of shares when first organized Investment company only issues fixed number of shares when first organized After all original shares have been issued, investors can only buy from one another After all original shares have been issued, investors can only buy from one another

36. Open-End Funds Most mutual are these type Most mutual are these type Unlimited number of shares issued and redeemed Unlimited number of shares issued and redeemed Can be bought and sold on any business day Can be bought and sold on any business day

37. Load Funds Mutual fund that you pay commission on every time you buy or sell Mutual fund that you pay commission on every time you buy or sell Can be as high as 8.5%, but average is 3 to 5% Can be as high as 8.5%, but average is 3 to 5% Supposed advantage is high commission means better advice and guidance Supposed advantage is high commission means better advice and guidance

38. No-Load Funds Has no commission fee Has no commission fee Should choose of load-funds Should choose of load-funds

39. Management Fees and Other Charges Management fees are fixed % of funds asset values – usually 0.5 to 1.25% Management fees are fixed % of funds asset values – usually 0.5 to 1.25% Back-end load – 1 to 5% fee charged for withdrawing money Back-end load – 1 to 5% fee charged for withdrawing money 12b-1 fee – charged to pay for marketing and advertising of mutual fund – 1% of assets 12b-1 fee – charged to pay for marketing and advertising of mutual fund – 1% of assets

40. Categories of Mutual Funds Stock Mutual Funds – made up of stocks and most mutual funds are this Stock Mutual Funds – made up of stocks and most mutual funds are this Bond Mutual Funds – made up of only mutual funds Bond Mutual Funds – made up of only mutual funds Mixed Mutual Funds – mix of stocks and bonds and other securities Mixed Mutual Funds – mix of stocks and bonds and other securities

41. Section 10.4

42. Considering Your Financial Goals When You Deal With Mutual Funds How old are you? How old are you? What is your family situation? What is your family situation? How much risk do you want to take? How much risk do you want to take? How much money do you make now? How much money do you make now? How much money are you likely to make in the future? How much money are you likely to make in the future?

43. Information On Mutual Funds Newspapers Newspapers Quotations Quotations Prospectuses Prospectuses Annual Reports Annual Reports Financial Publications Financial Publications Professional Advice Professional Advice Internet Internet

44. Return on Investment Gain income in one of three ways from mutual funds Gain income in one of three ways from mutual funds Income dividends – earnings from your mutual fund Income dividends – earnings from your mutual fund Capital gain distributions – payments made to shareholders that result from the sale of securities in the fund’s portfolio Capital gain distributions – payments made to shareholders that result from the sale of securities in the fund’s portfolio Capital gains - buying shares at a low price and selling after a price increase Capital gains - buying shares at a low price and selling after a price increase

45. Taxes and Mutual Funds Receive a 1099DIV which is a statement from brokerage firm showing distributions and dividends Receive a 1099DIV which is a statement from brokerage firm showing distributions and dividends1099DIV How they are taxed: How they are taxed: Dividends – taxed as regular income Dividends – taxed as regular income Distributions – reported on federal income tax return Distributions – reported on federal income tax return Gains/losses – reported on federal income tax return Gains/losses – reported on federal income tax returnfederal income tax returnfederal income tax return

46. Purchase Options Regular Account Transactions Regular Account Transactions Voluntary Savings Plans Voluntary Savings Plans Payroll Deduction Plans Payroll Deduction Plans Contractual Savings Plans Contractual Savings Plans Reinvestment Plans Reinvestment Plans

47. Regular Account Transactions Most popular Most popular Least complicated Least complicated Decide how much $ and when, and buy as many shares as possible Decide how much $ and when, and buy as many shares as possible

48. Voluntary Savings Plans Make smaller purchases than the minimum required by regular account transactions Make smaller purchases than the minimum required by regular account transactions Must commit to regular purchases from $25 to $100 generally Must commit to regular purchases from $25 to $100 generally

49. Payroll Deduction Plans Comes right out of check Comes right out of check Can also come from 401(k) and 403(b) retirement plans or IRAs Can also come from 401(k) and 403(b) retirement plans or IRAs

50. Contractual Savings Plans Required to make purchases over 10 to 20 years Required to make purchases over 10 to 20 years May pay penalties if purchases not made May pay penalties if purchases not made Not good choice because many investors lose money with these plans Not good choice because many investors lose money with these plans

51. Reinvestment Plans Income dividends and capital gain distributions are automatically reinvested Income dividends and capital gain distributions are automatically reinvested No additional sales charges or commissions charged to investor No additional sales charges or commissions charged to investor

52. Withdrawal Options Investment Period Withdrawal Investment Period Withdrawal Investment Period Liquidation Investment Period Liquidation Asset Growth Withdrawal Asset Growth Withdrawal Dividend and Distribution Withdrawal Dividend and Distribution Withdrawal

53. Investment Period Withdrawal May withdraw certain amount each period (3 months) until fund exhausted May withdraw certain amount each period (3 months) until fund exhausted Requires a minimum withdrawal amount, usually $50 Requires a minimum withdrawal amount, usually $50

54. Investment Period Liquidation Liquidate or “sell off” certain number of shares each period Liquidate or “sell off” certain number of shares each period

55. Asset Growth Withdrawal Allows a prearranged % of investment’s asset growth Allows a prearranged % of investment’s asset growth If no growth, no payment If no growth, no payment Principal remains untouched Principal remains untouched

56. Dividend and Distribution Withdrawal Allows withdrawal of all income from dividends and capital growth Allows withdrawal of all income from dividends and capital growth This option also allows principal to remain untouched This option also allows principal to remain untouched