Finance Chapter 10 Bonds and Mutual Funds

Corporate and Government Bonds 10-1 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.

Corporate and Government Bonds 10-1 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

Investing in Bonds Bond Price Quotations 10-2 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)

10-3 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 Funds Professional Management Diversification Reduce risk because money is spread out into a variety of securities An occasional loss can be offset by a gain in another investment.

Mutual Funds Types of Mutual Funds Closed End Funds Open 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) No Load 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 Mixed 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

Investing In Mutual Funds 10-4 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 Income Dividends – Earnings a fund pays the shareholder Capital Gains Distribution – Payments made to shareholders that result from the sale of securities in the funds portfolio 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 Indirect 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 Disadvantages 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 Collectibles 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