1. Investing in Bonds and Other Alternatives
Chapter 14
Investing in Bonds and Other Alternatives

2. Introduction Bonds carry less risk than stocks.
Bonds provide steady income.
But returns from bonds are not necessarily low.

3. Why Consider Bonds? Bonds reduce risk through diversification.
Bonds produce steady income.
Bonds can be a safe investment if held to maturity.

4. Basic Bond Terminology and Features
Par value
Maturity
Coupon Interest Rate
Indenture

5. Treasury and Agency Bonds
Risk-free
Not callable
Lower interest rate
Most interest payments are exempt from state and local taxes.

6. Treasury and Agency Bonds
Treasury-issued debt has maturities from 3 months to 10 years.
Bills, notes, and bonds differ by maturity and denomination.
Agency bonds

7. Treasury and Agency Bonds
Pass-through certificates issued by the Government National Mortgage Association “Ginnie Mae”
Treasury Inflation Protected Securities (TIPS)—par value changes with the consumer price index to guarantee investor a real rate of return

8. Municipal Bonds
“Munis”—issued by states, counties, cities, public agencies e.g. school districts
General obligation bond
Revenue Bonds
Serial maturities

9. Special Situation Bonds
Zero Coupon Bonds—don’t pay interest and are sold at a deep discount from their par value
Junk Bonds—also high-yield bonds, very risk, low-rated BB or below

10. Bond Ratings – A Measure of Riskiness
Moody’s and Standard & Poor’s provide ratings on corporate and municipal bonds.
Ratings involve a judgment about a bond’s future risk potential.
The poorer the rating, the higher the rate of return demanded by investors.
Safest bonds receive AAA, D is extremely risky.

11. Table 14.1 Interpreting Bond Ratings

12. Bond Yield
Current Yield—ratio of annual interest payment to the bond’s market price
Yield to maturity—true yield or return that the bondholder receives if a bond is held to maturity—measure of expected return
Equivalent taxable yield on municipal bonds

13. Bond Valuation
The value of a bond is the present value of the interest payments plus the present value of the repayment of the bond’s par value at maturity.

14. Bond Valuation
If the issuer becomes riskier, the required rate of return should rise.
A change in general interest rates, the required rate of return should increase.
When interest rates rise, the value of outstanding bonds falls.

15. Why Bonds Fluctuate in Value
Inverse relationship between interest rates and bond values in the secondary market.
When interest rates rise, bond values drop, and when interest rates drop, bond values rise.
Longer-term bonds fluctuate in price more than shorter-term bonds.

16. Why Bonds Fluctuate in Value
As a bond approaches maturity, the market value approaches its par value.
When interest rates go down, bond prices go up, but upward price movement on bonds with a call provision is limited by the call price.

17. Figure 14.3 The Price Path of a 12 Percent Coupon Bond over Its Life

18. What Bond Valuation Relationships Mean to the Investor
If you expect interest rates to go up (bond prices to fall)—purchase very short-term bonds.
If you expect interest rates to go down (bond prices to rise)—purchase bonds with long maturities and are not callable.

19. Figure 14.4 How to Read Online Corporate Bond Listings

20. Preferred Stock—An Alternative to Bonds
A hybrid security with features of common stock and bonds.
Similar to common stock—no fixed maturity date, not paying dividends won’t bring bankruptcy.
Similar to bonds—dividends are fixed, paid before common and no voting rights.

21. Investing in Real Estate
Requires time, energy, and sophistication
Direct investments in real estate
Indirect investments in real estate
Investing in real estate: the bottom line

22. Investing – Speculating in Gold, Silver, Gems, and Collectibles
Don’t do it!
This is not investing—it is speculation.
Collectibles may only have entertainment value.
Don’t expect them to provide for your financial future.