Investing in Bonds and Other Investments?????????

1
Chapter 14????

• Investing in Bonds and Other Investments?????????

2
Why Consider Bonds????????

• Bonds reduce risk through diversification.????????
  ?????
• Bonds produce steady current income.?????????
• Bonds can be a safe investment if held to
  maturity.??????,????,?????????

3
Basic Bond Terminology and Features??????????

• Par value the amount returned to the holder at
  maturity??-????????????????
• Coupon interest rate indicates the percentage
  of the face value that will be paid annually to
  the holder in the form of interest????-???????????
  ??????????
• Indenture a document that outlines the terms of
  the loan agreement??-?????????????

4
Basic Bond Terminology and Features
(contd)??????????(?)

• Call provision allows the issuer to repurchase
  the bonds before the maturity date??????-?????????
  ????????
• Deferred calls provide more protection.????????
• Sinking fund money set aside annually to pay
  off the bonds at maturity????-???????????,????????

5
Different Types of Bonds?????

• Corporate bonds????
• Treasury and agency bonds???????????
• Municipal bonds????
• Special situation bonds??????

6
Corporate Bonds????

• Secured corporate debts are secured by collateral
  or real property liens????????????????
• secured bond????
• mortgage bond????

7
Corporate Bonds (contd)????

• Unsecured corporate debts are not secured by
  collateral, and pay a higher return
  ?????????,??????,???????
• debenture long-term unsecured
  bond???????-???????
• can have a hierarchy of payment, with
  unsubordinated and subordinated
  debentures?????????

8
Treasury and Agency Bonds???????????

• Treasury bonds????
• Bills, notes, and bonds????????
• Treasury inflation-indexed bonds????????
• Savings bonds????
• U.S. Series EE bonds???? EE??
• I bonds I ??
• Agency bonds??????
• Pass-through certificates?????

9
Treasury Bills, Notes, and Bonds?????????

• Considered risk free no default or call
  risk???,???????
• Pay a lower rate of interest than other
  bonds?????????
• Most interest is exempt from state and local
  taxes???????????????????
• Treasury Direct avoids brokerage fees???????????

10
Treasury Bills, Notes, Bonds (contd)?????????(?)

• Bills mature in 3, 6, or 12 months?????3.6.
  ?12??????????
• Notes mature in 2, 3, 5, or 10 years??????2.3.5.?1
  0?????,??????
• Bonds mature in 10 to 30 years?????10 30????
• All are sold in denominations of
  1,000??????1,000
• Can be purchased directly from the
  Treasury.????????

11
Agency Bonds??????

• Issued by government agencies authorized by
  Congress?????????????????
• Federal National Mortgage Association
  (FNMA)????????
• Federal Home Loan Banks (FHLB)????????
• Low risk, with interest rates slightly higher
  than Treasury issues???,??????????
• Minimum denomination of 25,000 with maturities
  from 1 to 40 years???????25,000,????1 40?

12
Pass-Through Certificates?????

• Issued by Government National Mortgage
  Association (GNMA)???????????
• Minimum 25,000 certificate for pool of
  mortgages????25,000???????
• Principal and interest repaid monthly?????????

13
Treasury Inflation-Indexed Bonds??????

• Maturities of 10 years and a minimum par value of
  1,000?????1,000,????10?
• Inflation increases the face value of the bond,
  guaranteeing the investor a real
  return?????????????????????
• Tax complication must pay taxes annually on par
  value adjustments??????-?????????????????????

14
U.S. Series EE Bonds????EE??

• Purchase price is one-half of the face value,
  ranging from 50 to 10,000????????,?????50 -
  10,000 ??
• Rate of return varies with the market
  rate????????????
• Have a guaranteed minimum interest rate based on
  Treasury securities??????????????????
• High level of liquidity, but cashing in before
  maturity may reduce yield??????,?????????????,????
  ???

15
Municipal Bonds (Munis)????

• Issued by to fund public projects????????????????
• Interest earnings are federal tax-exempt??????????
  ?
• Can be exempt from state taxes if you live in the
  state where bonds issued ??????????????????????,??
  ?????????????
• Not very liquid, due to the lack of a secondary
  market?????,????????

16
Municipal Bonds (contd)????(?)

• Two basic types??????
• general obligation??????
• Revenue????
• Serial maturity a portion of the debt comes due
  each year for a set number of years????-??????????
  ??,??????
• Not risk free check the bond ratings????,??????

17
Special Situation Bonds??????

• Zero-coupon bonds ????
• Junk bonds????

18
Zero-coupon Bonds????

• Issued by corporations, municipalities, and the
  Treasury (e.g., STRIPS)??????????????(??STRIPS)
• Do not pay interest????
• Are sold at a discount from face value???????
• Annual appreciation is taxed although it is not
  realized?????????,???????????
• Fluctuate more with interest rate changes than
  traditional bonds????????????

19
Junk Bonds????

• Have very low ratings?????
• Normally offer very high interest rates????????
• Have a high default rate??????????
• Are almost always callable????????

20
Bond Yield???

• Is the total return on a bond investment?????????
• Is not the same as the interest rate???????
• Is affected by the bond price which may be more
  or less than face value???????,?????????

21
Ways to Measure Bond Yield????????

• Current yield?????
• Yield to maturity?????
• Equivalent taxable yield on munis ?????

22
Current Yield?????

• Ratio of annual interest payments to the bonds
  market price????????????????
• Current yield ?????
• annual interest payments ??????/??????
• market price of the bond

23
Yield to Maturity?????

• True yield received if the bond is held to
  maturity?????????,???????????
• Approximate yield to maturity ???????
• annual interest par value - current price
  
  payments years to
  maturity par value current
  price
• 2
• ???(?? - ????)/ ???? / (?? ???? /
  2)
• Equivalent Taxable Yield Equation for
  Munis??????????
• Equivalent taxable yield ?????
• tax-free yield on the municipal bond
• (1 - investors marginal tax bracket)
  ????????? / (1 ???????? )

24
Bond Ratings A Measure of Riskiness ????-?????

• Generally ratings run from AAA or Aaa for the
  safest to D for the extremely risky??????????????A
  AA????? D
• Ratings categorize bonds by default
  risk?????????????
• Rating companies??????
• Standard Poors????
• Moodys??

25
Corporate Bond Quotes in The Wall Street
Journal??????????

• Bonds the name of the issuer Bonds??-??????
• Cur Yld the annual interest divided by the most
  current price Cur Yld??????????????
• Vol the volume, or number, of bonds traded
  Vol??????????

26
Corporate Bond Quotes (contd)????(?)

• Close the last price paid for that issue.
  Measured in 1/8s or 1.25. ?????????????,???1/8s
  ? 1.25??
• Net Chg the change in closing price from the
  prior days closing price. Measured in 1/8s or
  1.25.??????????????????,???1/8s ? 1.25??

27
Reading Treasury Quotes in The Wall Street
Journal???????????

• Rate the original interest rate on the bond
  ??????????
• Maturity Mo/Yr the year and month the issue
  will mature ???/?????????
• Bid the previous days mid-afternoon bid price
  that Treasury dealers were willing to buy the
  issue for. Measured in 32nds of a point a point
  equals one-hundredth of par.?????????????????????
  ???,??32????,????????????
• Asked the previous days mid-afternoon ask
  price the Treasury dealers were willing to sell
  the issue for????????????????????????

28
Reading Treasury Quotes (contd)?????(?)

• Chg change from the prior days bid
  price??????????????
• Ask Yld is the effective rate of return on the
  investment???????????????
• STRIPS refers to zero-coupon bonds ???????????
• Days to Mat listed for T-bills due to their
  short maturity lengths ???????????????????

29
Bond Valuation Principles??????

• Value of a bond ????
• present value of present
  value of repayment
• all interest payments of par at
  maturity ????? ?????????
• Bonds fluctuate in value, and the longer the time
  to maturity the greater the fluctuation.???????,??
  ???????

30
Valuation Principles (contd)?????(?)

• Why would an investors required rate of return
  change???????????????
• Change in the risk associated with the firm
  issuing the bond.???????????
• Change in general interest rates in the
  market.???????????

31
Valuation Principles (contd)?????(?)

• As the available rate of return increases, the
  value of a lower rated bond decreases and an
  investor would pay a discount.??????,?????????????
  ??,?????????
• As the available rate of return drops, the value
  of a higher rated bond increases and an investor
  would pay a premium.??????,??????????????,????????
  ?

32
Valuation Principles (contd)?????(?)

• Interest rates affect bond valuation by changing
  the demand, and price, for a bond.????????????????
  ????
• Interest rates and bond values are inversely
  related in the secondary market. But the call
  price limits the upward price on a bond with a
  call provision.?????,???????????????,?????????????
  ????
• As a bond approaches its maturity date, its
  market value approaches it par value.??????????,??
  ?????????

33
Bond Valuation Relationships and The
Investor???????????

• If you expect interest rates to increase, buy
  short-term bonds.?????????,??????
• If you expect interest rates to decrease, buy
  long-term non-callable bonds.?????????,??????????

34
The Pros of Investing in Bonds?????????

• If interest rates drop, bond prices will
  rise.??????,???????
• Bonds reduce risk through diversification.????????
  ????
• Bonds produce steady current income.???????????
• Bonds can be a safe investment if held to
  maturity.??????????,?????????

35
The Cons of Investing in Bonds?????????

• If interest rates rise, bond prices will
  fall.??????,???????
• If the issuer experiences financial problems, the
  bondholder may lose.??????????,?????????
• If interest rates drop, rather than experiencing
  price appreciation, the bond may be
  called.??????,??????,????????

36
The Cons of Investing in Bonds (contd)?????????(?
)

• If you need to sell your bonds early, you may
  have a problem selling them at a reasonable
  price.?????????????,??????????????
• Finding a good investment outlet for the interest
  you receive may be difficult.?????????????????????
  ??

37
Analyzing Bond Choices??????

• Think about taxes.????
• Keep the inverse relationship between interest
  rates and bond price in mind.???????????????
• Avoid losers, and dont worry about picking
  winners.????,??????????
• Consider only high quality bonds.??????????
• Buy a bond when it is first issued, rather than
  in the secondary market.??????????????????????

38
Analyzing Bond Choices (contd)??????(?)

• Avoid bonds that might get called.??????????
• Match your bonds maturity to your investment
  time horizon.????????????????
• Stick to large issues.???????
• When in doubt, go Treasury!?????,???????

39
Preferred Stock An Alternative to
Bonds???-??????????

• Hybrid security with characteristics of stocks
  and bonds???????????????????
• Dividend payments can be skipped, without the
  company being bankrupt????????????
• Dividends are a fixed amount a fixed dollar
  amount or a percentage of the stocks par
  value??????,???????????????

40
Preferred Stock An Alternative to Bonds
(contd)???-??????????(?)

• Dividends are paid before common stock
  dividends??????????????
• Do not share in other profits with the common
  stockholders???????????????
• No voting rights????
• No fixed maturity date???????
• Rated like bonds, typically medium
  grade???????,????????

41
Features and Characteristics of Preferred
Stock?????????

• Multiple issues some companies have multiple
  issues of preferred stock, each with a different
  dividend????-?????????????,????????
• Cumulative feature all past unpaid dividends
  must be paid before common stock dividends are
  paid?????-??????????????,??????????????
• Adjustable rate the dividend rate changes with
  the market interest rate rather than letting the
  value of the stock drop??????-????????????????????
  ???

42
Features and Characteristics of Preferred Stock
(contd)?????????(?)

• Convertibility preferred stock can be exchanged
  for common stock at any time????-????????????????
• Callability issuer can repurchase the stock in
  case interest rates drop????-????????????????

43
The Valuation of Preferred Stock??????

• The value of preferred stock is the present value
  of the perpetuity of dividends?????? ?????????
• Value annual dividend
  required rate of return
• ????? ??????? / ??????

44
Risks Associated with Preferred Stock
Investing??????

• If interest rates rise, the value of the
  preferred stock drops.??????,???????
• If interest rates drop, the value rises, and the
  stock may be called.??????,??????????????

45
Risks Associated with Preferred Stock Investing
(contd)??????(?)

• Investors dont participate in the capital gains
  that common stockholders receive.?????????????????
  ???
• Preferred stock does not have the safety of a
  bond, because dividends can be passed without the
  risk of bankruptcy.???????????,???????????,???????
  ?

46
Investing in Real Estate?????

• Direct investments????
• vacation homes????
• commercial property (e.g., apartment buildings,
  office buildings, etc.)????(??????????)
• undeveloped land?????
• Indirect investments????
• real estate syndicates???????
• real estate investment trusts (REIT)???????

47
Real Estate Pros and Cons???

• Income produced with an opportunity of capital
  appreciation??????
• Few tax advantages???????
• Direct investment is active time, energy, and
  knowledge required?????????????????
• Illiquidity?????
• Overbuilding can hurt prices???????????

48
Investing (Speculating) in Metals, Gems,
Collectibles??(??)?????????

• Just Dont Do It!????
• Speculation is not investing.????????
• Collectibles are fine as entertainment, but not
  as savings vehicles.??????????,???????????
• Price depends on supply and demand.???????

49
Summary??

• Determinants of a bonds return??????
• Reasons to invest in bonds???????
• annual interest payments??????
• return of the par value?????
• Measures of bond returns???????
• current yieldd?????
• yield to maturity?????

50
Summary (contd)??(?)

• Sources of bonds?????
• Corporations??
• Treasury and other agencies?????????
• Municipalities????
• Bond ratings AAA to D???-AAA?D
• Bond valuation and the relationship with interest
  rates?????????

51
Summary (contd)??(?)

• Features of preferred stock??????
• Real estate investments?????
• Speculative investments precious?????-
  metals, gems, and collectibles?????????