Bonds and Mutual Funds

1. Bonds and Mutual Funds Chapter 10

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

3. What is Corporate Bond? • When purchased, basically loaning money to corporation • 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 • Face value - $ amount bondholder will receive at maturity • Typically $1,000, as high as $50,000 • Get paid interest semiannually until maturity

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

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

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

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

8. Convertible Bonds • Can be traded for shares of common stock • 1 to 2% lower than rates on other bonds • 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

9. Repaying Bonds • 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 • Selling stock • Using profits • Selling new bonds at lower interest rate

10. Methods to Repay Bonds • Premiums – paid if bonds called back early, additional amount above face value • 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

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

12. Responsibility to Bondholders • Bondholders must be repaid, stockholders do not • Interest must be paid on bonds, can choose to pay on stocks • 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? • Safer than stock • Provide interest income • May increase in value • Face value repaid at maturity

14. Interest Income • Registered Bonds – only owner can collect interest • 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) • Zero-Coupon Bonds – no interest payments made, but sold below face value

15. Market Value of Bond • 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 rise, the bond is worth less money on market • Financial conditions, as well as supply and demand, may affect market value • Selling at discount – selling for less than face value • Selling at premium – selling more than face value

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

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

18. Government Bonds and Securities • Treasury Bills • Treasury Notes • Treasury 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

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

20. Treasury Notes • Issued in $1,000 units • Maturity one to ten years • 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 • Issued in $1,000, with 10 to 30 years maturity • Interest rates usually highest among T-bills, and treasury notes

22. Series EE Savings Bonds • Purchase price half of face value • Can redeem 6 months to 30 years of purchase • Can receive interest up to 30 years • 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 • Also pay a variable interest rate that increases with inflation • Recalculated twice a year

24. State and Local Govt. Bonds • Municipal bond • Issued by state or local govt. to pay for ongoing activities or major projects • Classified as: • 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 • Govts. have defaulted on rare occasions

25. Section 10.2

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

27. Bond Price Quotation • In metropolitan newspapers, The Wall Street Journal, and Barron’s • Bond quotation is a % of face value (usually $1000) • 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: • Will it be repaid at maturity? • Will you receive interest payments until maturity? • Annual reports • Internet • Business magazines • Govt. reports and research

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

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

31. Section 10.3

32. What are mutual funds? • Investment alternative where investors pool money together • Buy stocks, bonds, and other securities • Professionals managers at investment companies make selections • 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 • Diversification – reduces risk, some may lose, but some may gain • 1970 – 361 mutual funds • 2003 – 8,300 mutual funds

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

35. Closed-End Funds • About 6% of all mutual funds • 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

36. Open-End Funds • Most mutual are these type • Unlimited number of shares issued and redeemed • 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 • Can be as high as 8.5%, but average is 3 to 5% • Supposed advantage is high commission means better advice and guidance

38. No-Load Funds • Has no commission fee • 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% • 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

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

41. Section 10.4

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

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

44. Return on Investment • Gain income in one of three ways from mutual funds • 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 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 • How they are taxed: • Dividends – taxed as regular income • Distributions – reported on federal income tax return • Gains/losses – reported on federal income tax return

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

47. Regular Account Transactions • Most popular • Least complicated • 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 • Must commit to regular purchases from $25 to $100 generally

49. Payroll Deduction Plans • Comes right out of check • 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 • May pay penalties if purchases not made • Not good choice because many investors lose money with these plans