Personal Finance Bonds Bill Klinger

Personal Finance Review Asset classes Markets Returns Risks Stocks (equities) Types Bid/ask Yield Buying Broker Market / limit order Indexes

Bonds (Fixed-income) Attributes Also known as fixed income Par value – amount on the bond (principal) Usually denominated in $1000 Interest rate to be paid (usually 2x a year) Maturity date – when principal is paid back Also known as fixed income Interest payments do not change over the life of the bond 1. By selling bonds, a firm obtains long-term debt capital. 2. issued in various denominations (face values), usually between $1,000 and $25,000 3. Because bondholders are creditors, they have a claim on the firm’s assets that must be satisfied before any claims of the stockholders in the event of the firm’s dissolution.

Bonds Characteristics Yield Yield to maturity Callable Convertible = annual interest / price NOTE: the price is the current price, not the par value Yield to maturity = rate will get if hold to maturity, includes par value

Types of Bonds Government Bonds Federal Agencies Municipal Bonds issued by U.S. Treasury (Treasuries) Sovereign debt Federal Agencies GNMA FHA, VA Municipal Bonds Interest is tax-free Issued by state and local governments Revenue bond is a bond whose proceeds are to be used to pay for a project that will produce revenue (e.g., a toll bridge) General obligation bond is a bond whose proceeds are used to pay for a non-revenue producing project (e.g., a fire station) Government bonds a. bonds issued by the U.S. Treasury b. are backed by the full faith and credit of the U.S. government c. they are considered the least risky of all bonds.

Corporate Bonds Secured Bond—bond backed by a pledge of a company’s specific assets. (Think collateral) Debenture—bond backed by the reputation of the issuer. (Think IOU) Secured bond a. backed by a specific pledge of company assets b. firms can issue secured bonds at lower interest rates than would be to paid for comparable unsecured bonds. Unsecured bond a. also called a debenture b. is backed only by the financial reputation of the issuing corporation

Bond Returns Interest Par value (principal) If sell before maturity Paid bi-annually Contractually obligated to pay Owe income tax Par value (principal) Paid at maturity Usually $1000 If sell before maturity Price has probably changed from $1000 Will have a capital gain or loss

Bond Value Present value of Uses all investors’ rate of return Annuity Principal Uses all investors’ rate of return Your required rate of return may differ

Bond Risk Default risk Interest rate risk Company or government is unable to pay Interest rate risk Bond interest rate does not change from what is printed on the bond (fixed income) If market interest rates change, it will affect how much people are willing to pay for the bond – the bond price Rates go up -> price goes down and vice versa Inflation risk – same story as interest rates

Moody’s and Standard & Poor’s Bond Ratings

Bonds Junk bonds AKA “high yield” bonds Don’t be fooled

Other Bonds U.S. Savings Bonds Zero coupon bonds Buy at a discount from par value Continue to earn interest for a period after maturity Zero coupon bonds Corporate bonds Pay no interest Sold at a discount

Bond Strategies Interest rate strategy Passive strategy Bet on expectation of interest rate changes Passive strategy Buy for long-term Maturity matching strategy Buy to match future expenses College Retirement living

In Class In groups of two Chapter 16 Financial Planning Exercises