Bonds, Economic Bonds.

What is a bond? Bonds are basically loans or IOUs given out by the government or a corporation. Ex. War Bonds

Components of a bond Coupon rate: interest rate paid to the “holder” Maturity: the time when the payment from the “issuer” to the “holder” is due 10, 20, 30 years Par value: the original purchase price of the bond repaid Aka: face value or principal

Stop…example time Sakurai issues 100 bonds worth $1,000 The coupon rate is 5% paid annually The maturity is 10 years You buy 1 bond. Every year Sakurai will give you $50 (coupon rate). After 10 years (maturity) Sakurai will give pay back your original 1,000 (par value) Original investment…$1,000 Return…$1,500

Buying bonds at a discount Sometimes bonds are not held to maturity. Can be sold before maturity Discount: buy a bond for less then the face value Why sell for less? Interest rates for other bounds might have gone up (ex. 8%). Ex. 1,000 bond bought for 900

Bond ratings Standard and Poor’s/ Moody’s Bond rating firms Rated on issuers ability to pay coupon rate and repay principal AAA/Aaa=best rating…D=lowest rating/default Better the bond rating, the lower the interest on the bond AAA (5%), Ca (10%) Better the bond rating, the more expensive the bond is $1,000 AAA bond may sell for $1,100

Advantages/Disadvantages for the issuer Coupon rate will not change Bondholders do not own part of the company Disadvantages: Must make interest payments (even if company didn’t make money) Lower bond rating if they can’t pay interest

Types of bonds Savings bonds: issued by gov., very safe, may purchase below face value, no regular interest payments Ex. $100 bond bought for $50, at maturity purchaser gets original $50 plus $50 interest Treasury bonds: issued by gov., very safe t-notes (2-10 years) and t-bills (3,6,12 months) Municipal bonds: issued by state and local gov., finance schools, parks, libraries, etc., interest not subject to income taxes

Types of bonds Corporate bonds: taxed as ordinary income, moderate risk watched by (SEC) Securities and Exchange Commission Regulates investment companies prohibits fraud Junk bonds: high risk, low rated, higher paying Ex. 12% coupon rate

Other Financial Assets Certificates of Deposit: Issued through a bank Attractive to small investors ($100) Deposited for fixed time (6 , 12, 18 months) Better interest rate then a bank account Mutual Funds: not covered by FDIC insurance

Financial Asset Markets Capital markets: money lent for longer than a year Ex. Long-term CDs, corporate and gov. bonds Money markets: money lent for less than a year Ex. Short-term CDs, t-bills, mutual funds

Financial Asset Markets Primary market: assets that can only be redeemed by the original holder Ex. Savings bonds Secondary market: assets that can be resold Provides liquidity