Investing in Bonds

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.

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.

Descriptive Terms for Bond Features

., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .

Registered and bearerZero-couponCallableWarrantsConvertibility

Language of Bond Investing

Indenture

Face value, coupon rate, maturity date

Secured and unsecured

Senior and subordinated

Language of Bond Investing

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

Corporate bonds

U.S. government securities

Treasury bills, notes, and bonds Federal agency issues

Municipal Bonds

Types of Bonds

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

Current Yield

Current yield = current annual income current market price = $55 $786 = 7%

State and Local Government Securities

Municipal Bonds

General Obligation Bonds

Revenue Bonds

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%

What is the Yield or Rate of Return on a Financial Investment?

=19.58%

100120

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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

Bond Ratings


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.

Susceptibility to certain risks

Credit

Callability

Inflation

Interest rate

Considerations Before Investing in Bonds

Premiums and discounts

Current yield

Yield to maturity

Tax-equivalent yields

When to sell

Considerations Before Investing in Bonds

Bond Prices, Bond Yields, and Interest Rates


Yield to Maturity

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%

1001

taxbracket

r

10028.1

05.

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

No hedge against inflation

Can be quite volatile

Compounding is almost impossible

Subject to investors tax rate

Poor marketability

Disadvantages of Investing in Bonds

Bond Characteristics and Risk


Investing in Bonds

Documents

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