Bonds as Financial AssetsBonds as Financial Assets  Bonds are similar to stocks, which pay the investor a fixed amount of interest at regular intervals for a fixed amount of time. The Coupon Rate is the interest rate that the bond issuer will pay to the bondholder. Maturity is the time at which payment to the bondholder is due. A bond’s Par Value is the amount that an investor pays to purchase the bond and that will be repaid to the investor at maturity.

How Bonds WorkHow Bonds Work 

Bonds as Financial AssetsBonds as Financial Assets  Suppose that you buy a $2000 bond from the corporation Starbucks. The investor who buys the bond is the holder, and the seller of the bond is the issuer; in this case you are the holder and Starbucks is the issuer. The coupon rate is 4 percent paid to the bondholder annually, maturity is 10 years and the par value is $2,000. Since the coupon rate is 4 percent per year, you will receive $80 every year, for the next 10 years. After 10 years, the bond will reach maturity and the company will have to repay the $2000 par value; in the end you will have received a total of $2800 for the $2000 bond.

Bonds as Financial AssetsBonds as Financial Assets  If the interest rate changes, a bonds value changes. If you purchase a $2000 bond at 5 percent and decide to sell it a year later when the new interest rate is 6 percent, no one will buy the bond for its par value because the new rate is higher, so you will have to sell the bond for less then what its worth. You may only get $1900 for it.

Bonds as Financial AssetsBonds as Financial Assets  Bonds are also rated. Bonds with higher ratings (AAA being the highest) are worth more then bonds with lower ratings (D being the lowest.) Ratings depend on whether payments are made on time and if the company is doing well or not, and if the bond will be held to maturity or not. A $2000 bond with a AAA rating may be worth around $2200, because of the high rating.

Bonds as Financial AssetsBonds as Financial Assets  Stocks are different from bonds because when you own a bond you don’t own a part of the company, so if the company does good you don’t get anything out of it.

Types of BondsTypes of Bonds  Savings bonds are low denomination ($50-$10,000) bonds issued by the government to pay for projects such as new schools and roads. Unlike regular bonds, the government does not send you regular payments on a regular schedule. Instead, the purchaser buys a savings bond for less then par value; you can buy a bond worth $50 for $25; when the bond matures you make get back the $25 investment plus $25 in interest.

Types of BondsTypes of Bonds  The United States Treasury Department issues Treasury bonds, as well as Treasury bills and notes. Treasury bonds are long term bonds, while Treasury notes are intermediate term and Treasury bills are short term.

Types of BondsTypes of Bonds  Municipal bonds (Munis bonds) are bonds issued to finance such improvements as highways, state buildings, libraries, parks, and schools. These bonds are considered safe because states have the power to tax.  Corporate bonds are high denomination bonds and are taxed as ordinary income. Corporations don’t have the power to tax people, so they are considered risky. Instead, they have to rely on the companies success to make regular payments to the investors.  Securities and Exchange Commission is an agency that regulates financial markets and investment companies. It enforces laws prohibiting fraud and other dishonest investment practices.

Types of BondsTypes of Bonds  Junk bonds are lower rated, and potentially higher- paying bonds. Junk bonds have been known to pay over 12 percent at a time while government bonds yield only 8 percent interest. They also carry a lower rating, so the can be a risky investment.

Other Types of Financial Assets  Certificates of Deposit (CD’s) are the most common forms of investment. They are available through banks, which lend out funds deposited in CD’s for a fixed amount of time, such as 6 months or a year.  Money Market Mutual Funds are short-term financial assets. Investors receive higher interest on a money market mutual fund than they would on a regular savings account. However, they are not covered by the FDIC, which covers up to $100,000 in savings accounts.

Financial Asset MarketsFinancial Asset Markets  Capital Markets are when money is lent for periods longer than a year, including long term CD’s and corporate and government bonds that require more than a year to mature.  Money Markets are when money is lent for periods less than a year, including short term CD’s, Treasury bills, and money market mutual funds.

Financial Asset MarketsFinancial Asset Markets  Primary Markets are markets for selling financial assets that can only be redeemed by the original holder. This includes savings bonds and small certificates of deposit because investors would most likely cash them in early rather than try to sell them to someone else.  Secondary Markets are markets for reselling financial assets. This option provides liquidity to investors; if there is a strong secondary market for an asset, the investor can quickly sell the asset without penalty.

Assessment  1. If the interest rate goes up, what happens to the value of your lower interest bond?  2. What are risky bonds called?  3. What’s the highest rating a bond can get?  4. What’s the lowest rating a bond can get?  5. What does “par value” mean?