1. Bonds & Mutual Funds
Chapter 10

2. Bonds Two types What is a bond Corporate Government
Essentially bondholder (investor) loaning money to a corporation or government entity

3. Why Issued Corporations Government
Way to raise $$ when it is difficult or impossible to sell stock
Government
To help fund its regular ongoing activities
Fund major projects
Government – sell to fund ongoing activities and to finance the national debt
State & local government – fund major projects - schools, airports, highways

4. Types of Corporate Bonds
Debentures
Mortgage
Subordinated Debentures
Convertible Bonds

5. Debentures
Bond backed by reputation of the issuing corporation – not by assets
Investors expect company to
Repay face value of the bond
Interest payments until maturity
Backed by reputation not be assets of issuing corporation
Investors buy this type of bond because they believe that the company/corporation is on solid financial ground.

6. Mortgage Bonds Also known as a secured bond
Backed by assets of the corporation
Less risk than a debenture
Lower return
Less risk than a debenture because backed by assets of corporation
Assets can be sold to repay bonds
Lower return because less risk

7. Subordinated Debentures
Unsecured bond
Bondholders have a claim to interest payments and assets of the corporation after all other bondholders have been paid
Riskier than other bonds
Higher return

8. Convertible Bonds Offer flexibility to investor
Can trade for shares of corporation’s common stock
Because of flexibility – interest rate 1 to 2 percent lower than on other types of bonds
Many bondholders do not convert their bonds into stock even when stock values are high.
Why? As market value of common stock increases so does the value of convertible bonds

9. How Repaid Premiums Sinking Funds Serial Bonds
If pay before a specified, pay a premium
Sinking Funds
Corporation makes deposits for purpose of pay back bond issue
Serial Bonds
Mature at different times – not all at once
Most bonds today are “callable” – they have a call feature that allows a corporation to buy back bonds from bondholders before the maturity date.
Do this by:
sell stock
use profits
or sell new bonds at a lower interest rate
Example: Mobil Corp issued bonds at 8.5%
Later interest rates on comparable bonds drops to 4.5%
Mobil may decide to “call” the bonds sold at 8.5%
Therefore, Mobil would not have to pay bondholders interest at the higher rate
Bond indenture – details all the conditions pertaining to a particular bond issue.
Side Note: Bonds, stocks, and mutual funds have prospectus’s – which is filed with the SEC outlining all the facts pertaining to issuance – risks, financial information about company, etc.
Premiums – companies agree not to call their bonds for the first 5 to 10 years after issued. If they do – may have to pay a premium – additional amount over the face value of the bond.
Serial – bonds mature at different intervals. For example, 10% of the bonds mature on an annual basis (usually no bonds mature for an initial period of time – 10 years). This allows corporation to repay bonds a few at a time instead of having to pay entire amount at once.

10. Why Buy Safe investment – relatively risk free Provide interest income
May increase in value
Face value repaid when reaches maturity
On the flip side – relatively low rate of return
Increase in value – depends on bond market, overall interest rates in the economy, and the reputation and assets of the issuer.

11. How Interest Paid Usually paid every 6 months Methods Registered bonds
Coupon bonds
Bearer bonds
Zero-coupon bonds

12. Registered Bonds & Coupon Bonds
Registered in owner’s name
Interest checks mailed to owner
Registered Coupon –
Registered in owner’s name for the face value only – not the interest
Comes with detachable coupons
Anyone who holds the coupons can collect the interest
Registered in owner’s name – owner is the only person who can collect the interest
Coupons Bonds – to collect interest present one of the detachable coupons to the issuing corporation or the appropriate bank or broker

13. Bearer Bonds & Zero-Coupon Bonds
Bearer – not registered in anyone’s name
Anyone with physical possession of bond and coupons can collect interest
Zero-Coupon – does not produce interest
Sold at a price far below its face value
Redeem for its full face value at maturity
Bearer bonds are no longer issued by corporations
Zero-Coupon – Because you buy it for less than its face value, you automatically make a profit when the bond is repaid

14. Maturity Value of a Bond
Market value of bond may fluctuate prior to maturity date
Bonds value affected by
Financial condition of the issuing company
Changes in the economy
Law of supply and demand

15. Repayment at Maturity Corporate bonds – repaid at maturity
After purchase investor can
Hold bond until maturity date
Sell the bond at any time to another investor
Value of bond closely tied to the corporation’s ability to repay

16. Where Purchase Bonds Purchased same way as stocks
Through a full-service, discount, or online brokerage firm – pay a commission
Purchase in either primary or secondary markets
Traded on the New York Bond Exchange and American Bond Exchange
Primary market – purchase from an investment banker representing the firm
Secondary market – trade financial securities with other investors
Bonds issued by large companies are traded on the New York Bond Exchange and American bond Exchange

17. Government Bonds & Securities
Federal government
Fund regular activities and services
Finance the national debt
Issued by the U.S. Dept of the Treasury
State and local governments
Finance airports, highways, schools
Relatively safe
Can get insured muni bonds
State and local government bonds known as “munis”

18. Government Bonds & Securities
U.S. Department of the Treasury offers
Treasury bills (T-bills)
Treasury notes
U.S. government savings bonds
Can be cashed prior to or held until maturity date
Must pay federal income tax on bond interest you receive
Bonds can be issued by other federal agencies as well.
Virtually risk free – offer only slightly higher interest rate than securities issued by the treasury department
Have an average maturity of about 12 years
Group Activity - Teaching Activity – page 315

19. Investing in Bonds Bond price quotations
Percentage of face value
Research – Internet, annual reports, business magazines, government reports, etc.
Check bond ratings
Calculate yield of bond investment
Bond price quotation is expressed as a percentage of the face value. Example, $1,000 – if the price quoted is “84” this means that the current market value is 84% or $840
Research – just like for stocks
Bond Ratings – bond issues are rated or evaluated by independent rating companies. Rating gives you a good idea of the quality and risk associated with that bond.
Sources for bond ratings: Moody’s Bond Survey and S&P Stock and Bond Guide
Handout – Bond Ratings – page 322
Yield of bond – is the rate of return
Amount of annual interest income/current market value – see GO Figure on page 323

20. Group Activity Research interest rates and other pertinent facts about
treasury bills, treasury notes, Series EE and I savings bonds
What are advantages & disadvantages of each
As a group which investment do you prefer and why
Divide students into 4 groups

21. Mutual Funds
Mutual Fund Scavenger Hunt

22. Mutual Funds
Investors pool their money to buy stocks, bonds, and other securities
Fund selections made by professional managers
Offer diversification – reduces risk
Very popular
1970 – 361 funds
2003 – 8,300 funds

23. Types of Mutual Funds Closed-End Funds Open-End Funds
Fixed number of shares issued
Shares are traded between investors on the stock exchanges
Open-End Funds
Unlimited number of shares issued
Redeemed by the investment company that manages the fund

24. Types of Mutual Funds Load Funds No-Load Funds
Referred to as an “A” fund
Pay a commission every time buy and sell
Advantage – fund’s representative will offer advice and guidance about when to buy and sell
No-Load Funds
No commissions paid
Load funds – commission can be as high as 8.5% - average load charge for mutual funds is between 3 ad 5 percent
FEES: Investment companies also charge management fees. Generally range from .5 to 1.25 percent of the fund’s assets.
Investors often charged a back-load fee versus being charged a fee when they purchase shares
Back-load – meaning you are charged a fee for withdrawing money from the fund, this usually ranges from 1-5 percent and is based on how long you own the shares
Also charged a 12b-1 fee – this is a fee for the marketing and advertising of a mutual fund – approx 1% of a fund’s assets per year

25. Fees and Other Charges Management Fee Back-end Load Fee 12b-1 Fee
Fixed % of the fund’s asset value
Range from .5 to 1.25%
Back-end Load Fee
Charge for withdrawing money
Range from 1 to 5%
Based on how long you own shares
12b-1 Fee
Helps pay advertising and marketing costs
Approximately 1% of fund’s assets per year

26. Capital Gain vs Capital Gain Distribution
Results from the sale of an investment
Proceeds from the sale minus initial cost
Capital Gain Distribution
Fund sells securities it holds
Profits distributed to the shareholders
Both are reported on your federal income
Receive a 1099 form at year end

27. Making Informed Decisions
Newspapers
Prospectuses
Annual Reports
Financial Publications
Professional Advice
Internet

28. Categories of Mutual Funds
Stock Mutual Funds
Bond Mutual Funds
Mixed Mutual Funds