UNIT 5: Investing Part 4.5: Corporate Bonds Dollars & Sense

Bonds: Review Everyone needs to borrow money You may need to borrow money for lunch or a soda. Businesses borrow money as well, but unlike you and me, it is awfully difficult to get borrowed money just with the promise to repay it the next day!

Corporate Bonds Businesses have to agree not only to pay back the amount they borrowed, but also to pay a little extra in the form of a fee (interest) for borrowing the money. Corporate Bonds: a loan sold to the public. Bonds are sold just like stock – through public securities markets.

Corporate Bonds Companies issue corporate bonds to raise money for a variety of purposes. Building a new plant Purchasing Equipment Expanding Business

Bonds: Review When you buy a corporate bond, you lend money to the company that issued the bond. In exchange, the company promises to return your money (principal)on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, generally semiannually (twice a year).

Bonds: Review For example: Let’s say you purchased a Corporate Bond from General Motors. The bond is a 10 Year, $1,000 bond. The annual interest rate is 8%, paid semi- annually for 10 years. You will collect $80 a year, for 10 years. ($800) After 10 Years, General Motors will return your $1,000. You will have started with $1,000 and ended with $1,800.

Corporate Bonds Corporate bonds tend to carry higher interest rates than government bonds because there is a risk that the company could go bankrupt. Unlike the government, which can just print more money if it really needs it!

Bonds: Terminology Par Value: the amount of money loaned by the investor. Also known as principal amount. Maturity Date: the date when the bond issuer has to return the principal amount to the lender (investor). Bond Yield: the return an investor would earn if a bond was purchased and held to maturity.

Corporate Bonds Let’s return to our example from before: You purchased a Corporate Bond from General Motors. The bond is a 10 Year, $1,000 bond. The annual interest rate is 8%, paid semi- annually for 10 years. You will collect $80 a year, for 10 years. ($800) Par Value = $1,000 Maturity Date = March, 2023 Yield = 8%

Corporate Bonds Sometimes companies have a hard time selling their bonds. What they can do is lower the Par Value or price of the bond. In our example from before, if General Motors was having a difficult time selling their bonds, they could sell a $1,000 bond for $950. The bond is still worth $1,000 – but you can buy at a discount!

How Do I Know If I Can Trust a Company? Remember, with Corporate Bonds there is always a chance your money may not be repaid….So, how do you know if you can trust a company to repay you? Lucky for you, there are Bond Ratings.

Rating Bonds Bond Ratings: developed to indicate how financially stable the issuer of the bonds is. Basically, the higher the rating, the higher quality of the bond, and the more likely you will get your money back on the maturity date.

Bond Ratings Bond Ratings are developed by third party services. Two common bond rating services are: Standard and Poor’s Moody’s Each service has its own rating system.

Moody’s Bond Ratings AaaExceptional security. (3%) AaExcellent security. AGood security. BaaAdequate security. BaQuestionable security. BPoor security. CaaVery poor security. CaExtremely poor security. CLowest security. (10%) Rating Interest Rate

Risk and Return Corporate bonds that carry a higher rating, will have a lower interest rate. You will likely receive all interest payments and principal. If a bond is rated Ba, B, Caa, Ca, or C it is considered a “Junk Bond” Junk Bond: called junk bonds, because the credit quality of the business is not high. Junk Bonds in general, carry very high interest rates!

Corporate Bond Worksheet Your task is to calculate the interest payments for different rated bonds. Go to the class website and download the calculatingbond_activity.doc, save to your H:// drive. to Mr. Farrar when you have completed the worksheet