Dr. Steven M. Hays BKHS Personal Finance

 Corporation’s written pledge to repay a specified amount of money with interest.  The face value is the dollar amount that the bondholder will receive at the bond’s maturity date-usually $1,000.  Bondholders receive interest payments every six months at the stated interest rate.  The legal conditions are described in a bond indenture.  A trustee is a financially independent firm that acts as the bondholder’s representative.  Corporations may call in, or buy, outstanding bonds from bondholders before the maturity date. 15-2

 To get funds for major purchases.  To fund ongoing business activities.  When it is difficult or impossible to sell stock.  To improve financial leverage.  Interest paid to bondholders is a tax deductible business expense that can be used to reduce the federal and state taxes corporations must pay. 15-3

 Debenture Bond  Mortgage Bonds  Subordinated Debenture Bond  Convertible Bond 15-4

◦ Most corporate bonds are debenture bonds. ◦ Unsecured - Backed only by the reputation of the issuing company.

◦ A corporate bond that is secured by various assets of the issuing firm, usually real estate. ◦ Interest rate is lower because it is secured

An unsecured bond that gives bondholders a claim secondary to that of other designated bond holders with respect to interest payments and claim on assets.

◦ A special kind of corporate bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock.

 Issued by smaller companies who may find it costly to issue stock or bonds  Typically by more speculative companies  Buy a convertible bond if you are bullish on the stock  Convertible bond allows you the opportunity to collect interest, semi-annually  With the option to convert to stock, the income paid will be less than a traditional bond  Offer investors the opportunity to participate in the equity market while collecting interest

 Corporation can call in or buy back outstanding bonds from current bondholders before the maturity date.  Most agree not to call bonds for the first 5 to 10 years after they are issued.  Bonds called if their interest rate is much higher than the going rate.  Most corporate bonds are callable. 15-6

 Sinking fund. ◦ Corporations deposit money in this fund annually or semiannually and use the money to pay off the bondholders when the bond issue comes due.  Serial bonds. ◦ Bonds of a single issue that mature on different dates. 15-7

 For interest income. ◦ Investors know the interest rate. ◦ Interest will be paid to investors twice a year, with the payment based on the interest rate and the face value of the bond.  Appreciation of bond value. ◦ May be able to sell a bond with a fixed interest rate to someone else at a higher price if overall interest rates fall.  Bond face amount will be repaid at maturity. 15-8

 Registered bond: Registered in your name by the company who issued it. Interest checks will be mailed directly to you.  A bearer bond is not registered in your name. Also has detachable coupons. No longer issued by U.S. corporations.  Zero coupon bonds: Sold for below face value; it pays no interest; redeem it for face value at maturity. Interest is taxed as you earn it. 15-9

 Individuals can hold bond until maturity or sell it in the secondary market.  Success or failure of the business and changes in market interest rates will affect the price of the bond.  Interest and capital gains from selling bonds are both taxable.

 Sold to obtain money to finance the national debt and the ongoing costs of government.  Three levels of government issue bonds: ◦ Federal-no state income tax on the interest. ◦ State. ◦ Local municipalities.

Treasury Bills (T-Bills).  $1,000 minimum.  4, 13, 26, or 52 weeks to mature.  Sold at a discount. Treasury Notes (T-Notes).  $1,000 units.  2, 3, 5, 7 and 10 year terms.  Interest paid every six months, higher rates than T-bills

 Pay a lower interest rate than corporate bond, but virtually risk free if chosen carefully.  Often used by investors to diversify their investment holdings.

 Fannie Mae ( ◦ Federal National Mortgage Association.  Ginnie Mae - pay interest once a month. ◦ Government National Mortgage Association.  Freddie Mac. ◦ Federal Home Loan Mortgage Corporation.  Slightly higher risk than Treasury securities, so slightly higher interest rates.  Issued for 1-30 years, 12 year average.  Minimum may be as high as $25,000.

 Municipal bonds or “munis”  Issued by a state or local government, such as cities, counties, school districts  Use funds for ongoing costs & to build major projects such as schools, airports, and bridges  General obligation bonds are backed by the state or local government that issues them  Revenue bonds are repaid from money generated by the project the funds finance, such as a toll bridge

 People like to invest in projects close to home.  They like insured municipal bonds, or states that guarantee payment.  May be callable, but usually not until after the first ten years.  Interest earned may be exempt from federal income tax so yield is higher.

Tax-exempt yield Your tax rate Example: Taxable equivalent yield = 0.06 (6%) = = 8.3%

 Will the bond be repaid at maturity?  Will you receive interest payments until maturity?  Read the annual report, looking for strengths and weaknesses.  Bond ratings? (see Exhibit 15-6). ◦ Rating range from AAA to D. ◦ BB or below is called a junk (speculative) bond. ◦ Rated by Standard and Poors and Moodys, with information on their websites, ◦ are online sources of information on bonds.

 Standard and Poors  Moodys

 Issues opinion on the general creditworthiness of an obligor, or the creditworthiness of an obligor with respect to a particular debt security or other financial obligation.  Credit ratings have achieved wide investor acceptance as convenient tools for differentiating credit quality. 

 System of rating securities was originated by John Moody in 1909  Purpose is to provide investors with a simple system of gradation by which future relative creditworthiness of securities may be gauged  Gradations of creditworthiness are indicated by rating symbols

 Read bond quotes in the newspaper. ◦ Bid price is the highest price offered for the bond during a day (market value). ◦ Asked price is the lowest price at which someone has offered to sell a bond during a day. ◦ Look at the maturity date. ◦ Determine the current yield. ◦ A bond listed at 100 is really selling for $1, (continued)

Example: Current yield = $75 $800 = = 9.4% The Investment’s Current Market Value Dollar Amount of Income Generated Yearly

 Go to one of these sites and look up information about municipal bonds in your area.    Print the cover page of the bond that you choose  Determine the taxable equivalent yield for a bond from the City of Rochester, Greece, Irondequoit, Gates, Chili, Webster, Penfield, Brighton, Henrietta, or other municipality in the area  What do you think of the rates these bonds are paying?