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Bonds

Bonds. Corporations Get money by… Issuing Stock (equity financing) Selling Bonds (debt financing). Government Entities Get money by Selling Bonds Since they are non-profit, they can not issue stock. Need Money?. What is a Bond?.

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Bonds

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  1. Bonds

  2. Corporations Get money by… Issuing Stock (equity financing) Selling Bonds (debt financing) Government Entities Get money by Selling Bonds Since they are non-profit, they can not issue stock. Need Money?

  3. What is a Bond? • A bond is a loan (IOU) given to a lender (investor) by a borrower (corporation or government entity) that needs money. • Selling a bond is simply borrowing money from the public. When you buy a bond you are essentially lending money to a corporation or government entity. ____________________________ Corporations/Government Entities You and I Borrowers Lenders/Investors

  4. What is a Bond? • Bonds promise to pay back the lender the entire amount of the loan on a particular day. They also pay the lender something additional for the use of his money (interest). (Debt Financing) • Stocks promise….NOTHING! With stocks, you share in the success and failure of the company. (Equity Financing)

  5. The ABC’s of Bonds • Read The ABC’s of Bonds and complete the questions. • You are responsible for understanding the information in this handout.

  6. How Bonds Work • Review How Bonds Work • Summary… • Coupon bonds pay out interest at set intervals, with a final payment that includes the original principal at the maturity date. • Zero-coupon bonds, on the other hand, pay all the interest and principal of the bond at the maturity date. • You are responsible for understanding the information in this handout.

  7. Why Buy a Bond? • Historically, stocks have resulted in greater profits for investors than bonds. Why, then, should you consider investing in bonds? • Read Why Buy a Bond and answer the question. • I am specifically looking for four (4) reasons investors would buy bonds. Be prepared to reference the text for each reason. • You are responsible for understanding the information in this handout.

  8. Bond Ratings • Read Bond Ratings – bonds are often rated; the ratings are intended to provide information to investors. • You are responsible for understanding the information in this handout.

  9. Most Corporate Bonds are Callable • A call feature allows a corporation to buy back bonds from bondholders before the maturity date. • Corporations may get the money to call a bond by issuing more stock, using profits, or selling new bonds at a lower interest rate. • Typically companies agree not to call their bonds for the first 5 to 10 years. • When they do call their bonds, they may have to pay bondholders a premium, which is an additional amount above the face value of the bond.

  10. Risks for the Investor • Repayment Risk • Interest Rate Risk • Inflation Risk

  11. Risks for the Investor Repayment Risk • Refers to the borrowers ability to pay interest and repay principle timely. • The credit rating of a bond indicates the degree of repayment risk.

  12. Risks for the Investor Interest Rate Risk • The risk that interest rates rise and you are stuck with a fixed rate investment paying interest below the current market. • Bonds lose value when interest rates increase after the bond is issued. • If you own a bond at 8%, the current market rate is 10%, and you wanted to sell (to put your money in an investment making a higher rate of return)…investors will be willing to pay less than face value for your bond. • You’d have to sell it at a discount , “put in on sale”. You’d sell it for less than its face value because no one will want to pay full price for a bond paying interest below the current market.

  13. Risks for the Investor Inflation Risk • Inflation is the general rise in prices over time. • Since the dollar amount you earn on a bond doesn’t change, the value of that income can be eroded by inflation. $1000 $1,030 $30 $30 $30 $30 $30 |____|____|____|____|____|____| Buy Maturity Date Bond 3 Years • That $60 of annual income buys less at the end of the term than at the beginning. Why? Because items will cost more at maturity than they did 3 years ago. • The same $60 will buy less!

  14. Why Issuers Prefer Bonds • Issuing more stock can dilute (lessen) the value of the common stock already outstanding. Earnings EPS = ------------------------- Shares Outstanding • Income tax advantages to issuing bonds • A corporation can reduce its taxable income by the amount of interest it pays to bondholders.

  15. How to Read a Bond Table • Read the handout about Bond Price Quotations, Yield of a Bond Investment, and Reading a Bond Table. • You are responsible for understanding the information in this handout.

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