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Investing in Bonds
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Objectives Describe bonds and how they are used by corporations and investors. Describe the major characteristics of bonds. Differentiate among the four general types of bonds.
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Objectives Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity. List the advantages and disadvantages of investing in bonds.
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Descriptive Terms for Bond Features., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890.http://www.flatworldknowledge.com/node/50890
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Registered and bearer Zero-coupon Callable Warrants Convertibility Language of Bond Investing
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Indenture Face value, coupon rate, maturity date Secured and unsecured Senior and subordinated Language of Bond Investing
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Interest Income Assume you purchase $1,000 corporate bond issued by AT&T Corporation. The interest rate for this bond is 6.70%. The annual interest is $67 as shown below: Dollar amount of annual return = Face value x interest rate = 1,000 x 6.7% = 1,000 x.067 = $67.00
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Corporate bonds U.S. government securities Treasury bills, notes, and bonds Federal agency issues Municipal Bonds Types of Bonds
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Approximate Bond Value Assume you purchase a Verizon Communications bond that pays 5.5% interest based on a face value of $1,000 until maturity in 2017. Also assume new corporate bond issues of comparable quality are currently paying 7%. The approximate market value of your Verizon bond is $786 calculated as follows: Dollar amount of annual interest = $1,000 x 5.5% = $55 Approximate market value = Dollar amount of annual interest Comparable interest rate = $55 7% = $786
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Current Yield Current yield = current annual income current market price = $55 $786 = 7%
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State and Local Government Securities Municipal Bonds General Obligation Bonds Revenue Bonds
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Effective Yield of a Tax-Free Investment Not paying tax effectively increases your rate of return you get to keep all of your profits, instead of only a portion Example: 28% tax bracket, 5% rate of return = 6.94%
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What is the Yield or Rate of Return on a Financial Investment? Annualized Percentage Change: Example: original price=$20/share, current price=$100/share, stock held for 9 years
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Comparison of Taxable vs Tax Exempt Investments Tax- Exempt Yield 15% Tax Rate 25% Tax Rate 28% Tax Rate 33% Tax Rate 35% Tax Rate 4%4.71%5.33%5.56%5.97%6.15% 5%5.88%6.67%6.94%7.46%7.69% 6%7.06%8.00%8.33%8.96%9.23% 7%8.24%9.33%9.72%10.45%10.77%
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What is the Yield or Rate of Return on a Financial Investment? =19.58%
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Bond Price Calculation Assume that a bond has a price quote of 84. The actual price for the bond is $840, as calculated below: Bond price = Face value (usually $1,000) x bond quote = $1,000 x 84 percent = $1,000 x.84 = $840
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Bond Ratings., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890.http://www.flatworldknowledge.com/node/50890 A plus sign (“+”) following a rating indicates that it is likely to be upgraded, while a minus sign (“-“) following a rating indicates that it is likely to be downgraded.
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Susceptibility to certain risks Credit Callability Inflation Interest rate Considerations Before Investing in Bonds
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Premiums and discounts Current yield Yield to maturity Tax-equivalent yields When to sell Considerations Before Investing in Bonds
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Bond Prices, Bond Yields, and Interest Rates., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890.http://www.flatworldknowledge.com/node/50890
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Yield to Maturity
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Effective Yield of a Tax-Free Investment Not paying tax effectively increases your rate of return you get to keep all of your profits, instead of only a portion Example: 28% tax bracket, 5% rate of return = 6.94%
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Pay higher interest rates than savings Offer safe return of principle Have less volatility than stocks Offer regular income Require smaller initial investment Advantages of Investing in Bonds
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No hedge against inflation Can be quite volatile Compounding is almost impossible Subject to investors tax rate Poor marketability Disadvantages of Investing in Bonds
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Bond Characteristics and Risk., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890.http://www.flatworldknowledge.com/node/50890
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