1. Bonds, Economic Bonds.

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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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