Bonds and OtherFinancial Assets

Objectives You may wish to callstudents’ attention to the objectivesin the Section Preview. The objec-tives are reflected in the main head-ings of the section.

Bellringer Ask students whetherthey have ever heard the expression“His word is as good as his bond.”Explain that it means that a person’sword is as trustworthy as a financialarrangement for which a person haslegal liability. Tell the class that inthis section they will learn aboutbonds and promises.

Vocabulary Builder Have studentsread through the section to find themeaning of each key term. Then askthem to create a matching quiz withthe key terms.

Interest Rates Tobuildunderstandingof theconceptof interest ratesand investmentopportunities, havestudents completea treemapgraphicorganizer liketheone shownat the right.Remindstudents thata treemapshowsanoutlineofamaintopic,main ideas,andsupportingdetails.Theyshouldplace the title“FinancialAssets”at the topof theorganizer.Eachmainheading in thesectioncango intooneof thenexttierofboxes,withsupportingdetails listedbelow.

Section Reading Support Transparencies A tem-plate and the answers for this graphic organizercan be found in Chapter 11, Section 2 of theSection Reading Support Transparency System.

Graphing the Main IdeaB U I L D I NGB U I L D I NG

K E Y CONCE PTSK E Y CONCE PTS

ChaptChapter er 1111 •• Section Section 22

Guided Reading and ReviewUnit 4 folder, p. 15 asks students toidentify the main ideas of the sectionand to define or identify key terms.

HH ow do borrowers raise money forinvestment? One of the most important

ways is by selling bonds. As you read inChapter 8, bonds are certificates sold by acompany or government to finance projectsor expansion.

For example, starting in 1942, the UnitedStates Department of Treasury launchedbond drives to encourage Americans tobuy “war bonds”—government savingsbonds that helped finance World War II.Movie stars and war heroes urged thepublic to buy bonds. Even school childrenbrought their dimes and quarters to schooleach week, buying defense stamps thatwould eventually add up to the price of awar bond.

Bonds as Financial AssetsBonds are basically loans, or IOUs, thatrepresent debt that the government or acorporation must repay to an investor.Bonds typically pay the investor a fixedamount of interest at regular intervals for afixed amount of time. Bonds are generallylower-risk investments. As you mightexpect from your reading about the rela-tionship between risk and return, the rateof return on bonds is usually also lowerthan for other investments.

The Three Components of Bonds Bonds have three basic components:

• Coupon rate The coupon rate is theinterest rate that the bond issuer will payto the bondholder.

• Maturity Maturity is the time at whichpayment to the bondholder is due.

coupon rate theinterest rate that abond issuer will pay toa bondholder

maturity the time atwhich payment to abondholder is due

Bonds and OtherFinancial Assets

Section FocusCorporations andgovernments borrow moneyby selling bonds and otherfinancial assets. Thecorporation or governmentpays the purchaser interest on the bonds and repays theprincipal, or money borrowed,at a specified time.

Key Termscoupon rate maturity par valueyieldsavings bondmunicipal

bondcorporate

bond

Securities and Exchange Commission

junk bondcapital marketmoney marketprimary marketsecondary

market

ObjectivesAfter studying this section you will be able to:1. Describe the characteristics of bonds as

financial assets.2. Identify different types of bonds.3. Describe the characteristics of other types

of financial assets.4. Explain four different types of financial

asset markets.

Preview

� This poster usedpowerful images toconvince people tobuy war bondsduring World War II.

Lesson PlanTeaching the Main Concepts

1. Focus Bonds provide a popular wayfor institutions to raise capital and forinvestors to seek a reasonable rate ofreturn on their investments. Ask stu-dents to identify any kinds of bonds withwhich they are familiar.2. Instruct Begin by explaining thecharacteristics and types of bonds.Explain how bonds are rated and whatthe ratings mean. Then introduce stu-dents to other types of financial assetsalong with the advantages and draw-backs of each. Finally, discuss financialasset markets.3. Close/Reteach Remind students thatborrowers and investors use bonds andother financial assets to achieve spe-cific financial goals. Ask students torecall the different types of bonds and torate their respective risks.

L3

277

Ask students to create a fact sheet thatexplains the characteristics of bonds asfinancial assets. Remind them that thefact sheet should be aimed at peoplewho do not understand what bondsare or how they work. Encourage stu-dents to use a format (such as questionand answer) that allows them toexplain bonds concisely.

ChaptChapter er 1111 •• Section Section 22

278

Interest Rates Explain to students that a bond’smaturity is the time at which payment to the bond-holder is due. At that point the bondholder receivesthe par value of the bond, and the company’s debt isrepaid. While the bond is maturing, the bondholderreceives interest payments determined by the coupon

rate. Ask students to work in pairs and presenteach other with various coupon rates, maturities,and par values. Each pair of students should calcu-late the return on the investment they describe.

Econ 101: Key Concepts Made EasyEcon 101: Key Concepts Made Easy$

BackgroundEconomics in HistoryEconomics in HistoryThe war bond drives of World War IIfeatured famous entertainers andbolstered public support for the war.However, these bond drives added lit-tle to the nation’s war chest. WorldWar II cost the federal governmentabout $321 billion, of which 41 percentcame from taxes. Where did the restof the money come from?

The answer lies in “defense eco-nomics,” of which war finance is abranch. Generally wars are financedby taxes, compulsory loans, voluntarydomestic loans, foreign loans, andprinting of new money.

Compulsory loans are short-term,mandatory loans made to governmentby the public. Usually the public thinksof these “loans” as taxes. Voluntarydomestic loans result from the sale ofgovernment bonds. Some are pur-chased by the public, in the form ofwar bonds, but the rest are financedby banks.

The least desirable form of warfinancing is the printing of newmoney. A government that is forced toprint money has probably exhaustedall other borrowing options. The moremoney it prints, the less that money isworth. If the government printsenough new money, the currency willbecome worthless.

Answer to . . . Building Key Concepts Rising inter-ests rates drive bond prices down.

Different bonds have different lengths ofmaturity. Bonds typically mature in 10,20, or 30 years.

• Par value A bond’s par value is theamount that an investor pays to purchasethe bond and that will be repaid to theinvestor at maturity. Par value is alsocalled face value or principal.

Suppose that you buy a $1,000 bondfrom the corporation Jeans, Etc. Theinvestor who buys the bond is called the“holder.” The seller of a bond is the“issuer.” You are therefore the holder ofthe bond, and Jeans, Etc. is the issuer. Thecomponents of this bond are as follows:

• Coupon rate: 5 percent, paid to thebondholder annually

• Maturity: 10 years • Par Value: $1,000

How much money will you earn fromthis bond, and over what period of time?The coupon rate is 5 percent of $1,000 peryear. This means that you will receive apayment of $50 (.05 times $1,000) eachyear for ten years, or a total of $500 ininterest. In ten years, the bond will havereached maturity, and Jeans, Etc. will retirethe debt. This means that the company’sdebt to you will have ended, and that Jeans,Etc. will pay you the par value of the bond,or $1,000. Thus, for your $1,000 invest-ment, you will have received $1,500 over aperiod of ten years.

Not all bonds are held to maturity. Overtheir lifetime they might be bought orsold, and their price may change. Becauseof these shifts in price, buyers and sellersare interested in a bond’s yield, or yield tomaturity. Yield is the annual rate of returnon the bond if the bond were held tomaturity (5 percent in the example aboveinvolving Jeans, Etc.).

Buying Bonds at a Discount Investors earn money from interest on thebonds they buy. They can also earn moneyby buying bonds at a discount, called adiscount from par. In other words, if Natewere buying a bond with a par value of$1,000, he may be able to pay only $960for it. When the bond matures, Nate willredeem the bond at par, or $1,000. He willthus have earned $40 on his investment, inaddition to interest payments from thebond issuer.

Why would someone sell a bond for lessthan its par value? The answer lies in thefact that interest rates are always changing.For example, suppose that Sharon buys a$1,000 bond at 5 percent interest, which isthe current market rate. A year later, sheneeds to sell the bond to help pay for a newcar. By that time, however, interest rateshave risen to 6 percent. No one will pay$1,000 for Sharon’s bond at 5 percentinterest when they could go elsewhere andbuy a $1,000 bond at 6 percent interest.For Sharon to sell her bond at 5 percent,she will have to sell it at a discount. (SeeFigure 11.3.)

par value the amountthat an investor pays topurchase a bond andthat will be repaid tothe investor at maturity

yield the annual rate ofreturn on a bond if thebond were held tomaturity

Figure 11.3 Discounts from ParFigure 11.3 Discounts from Par

$1,000Bond$1,000Bond$1,000$1,000

$1,000Bond$1,000Bond$960$960

Bond purchase without discount from par

Bond purchase with discount from par

1. Sharon buys a bond with a par value of $1,000 at 5 percent interest.

2. Interest rates go up to 6 percent.

3. Sharon needs to sell her bond. Nate wants to buy it, but is unwilling to buy a bond at 5 percent interest when the current rate is 6 percent.

4. Sharon offers to discount the bond, taking $40 off the price and selling it for $960.

5. Nate accepts the offer. He now owns a $1,000 bond paying 5 percent interest, which he purchased at a discount from par.

=

=

Investors can earn money bybuying bonds at a discount,called a discount from par.Interest Rates How do interestrates affect bond prices?

L3

Standard & Poor’s and Moody’sprovide investment services otherthan bond ratings. Have a smallgroup of students research bothcompanies and create an illustratedpresentation to explain their find-ings. Ask them to explore the typesof investor services each companyprovides and how these services helpinvestors to make informed choices.GT

To help students understand bondratings and the opportunity costinvolved in choosing one bond overanother, instruct pairs of students tocomplete the following exercise.First, ask each pair to read throughthe part of the section titled “Bondsas Financial Assets,” starting on p. 277. Then, instruct one student topresent a hypothetical bond to theother, including information aboutbond rating and interest rate. Askthe other student to respond verballyby describing the trade-off he or shewould make by buying that bond.Then have students switch roles.(Example: One student presents abond with a AAA Standard & Poor’srating with an interest rate of 4.5percent. The other student respondsby saying that the buyer is giving upa higher interest rate to gain a secureinvestment.)

Transparency Resource Package Economics Concepts, 11C:

Bond Reports

279

ChaptChapter er 1111 •• Section Section 22

Answer to . . . Building Key Concepts AAA andAaa

Consider these suggestions to take advantage ofextended class time:

� Devote some class time to showing studentshow to read the business section of a newspaper.Provide small groups with copies of a nationaldaily newspaper. Point out how the variety ofinformation can help students invest wisely. Havestudents create their own how-to manual forreading these sections of the newspaper.

� Extend the first activity on this page by con-ducting an in-class tour of Web sites related tosecurities. Have students create a brochure point-ing out what is offered at each site. Have studentsuse the links provided in the Economics:Principles in Action segment in the Social Studiesarea at the following Web site:www.phschool.com

Block Scheduling StrategiesBlock Scheduling Strategies

Bond RatingsHow does an investor decide which bondsto buy? Investors can check bond qualitythrough two firms that publish bondratings. Standard & Poor’s and Moody’srate bonds on a number of factors,including the issuer’s ability to make futureinterest payments and to repay the prin-cipal when the bond matures. Thesecompanies’ rating systems rank bondsfrom the highest investment grade (AAA inthe Standard & Poor’s system or Aaa inthe Moody’s rating system) to the lowest(D in both systems). A bond rating of Dgenerally means that the bond is indefault—that is, the issuer has not kept upwith interest payments or has defaulted onpaying principal.

The higher the bond rating, the lower theinterest rate the company usually has topay to get people to buy its bonds. Forexample, a AAA bond may be issued at a5 percent interest rate. A BBB bond,however, may be issued at a 7.5 percentinterest rate. The buyer of the AAA bondtrades off a lower interest rate for lowerrisk. The buyer of the BBB bond tradesgreater risk for a higher interest rate.

Similarly, the higher the bond rating, thehigher the price at which the bond will sell.For example, a $1,000 bond with an AAA

(or “triple A”) rating may sell at $1,100. A$1,000 bond with a BBB rating may sell foronly $950 because of the increased riskthat the seller could default.

In essence, holders of bonds with highratings who keep their bonds untilmaturity face relatively little risk of losingtheir investment. Holders of bonds withlower ratings, however, take on more riskin return for potentially higher interestpayments.

Advantages and Disadvantages to the IssuerFrom the point of view of the investor,bonds are good investments because theyare relatively safe. Bonds are desirablefrom the issuer’s point of view as well, fortwo main reasons:

1. Once the bond is sold, the coupon ratefor that bond will not go up or down.For example, when Jeans, Etc. sellsbonds, it knows in advance that it will bemaking fixed payments for a specificlength of time.

2. Unlike stockholders, bondholders do notown a part of the company. Therefore,the company does not have to shareprofits with its bondholders if thecompany does particularly well.

Standard & Poor’s Moody’s

Highest investment gradeHigh gradeUpper medium gradeMedium gradeLower medium gradeSpeculativeVulnerable to defaultSubordinated to other debt rated CCCSubordinated to CC debtBond in default

Best qualityHigh qualityUpper medium gradeMedium gradePossesses speculative elementsGenerally not desirablePoor, possibly in defaultHighly speculative, often in defaultIncome bonds not paying incomeInterest and principal payments in default

AaaAaA

BaaBaB

CaaCaCD

AAAAAA

BBBBBB

CCCCCCD

Figure 11.4 Bond RatingsFigure 11.4 Bond Ratings

Standard & Poor’s and Moody’s rate bonds according to their assessments ofthe issuer’s ability to make interest payments and to repay the principal whenthe bond matures.Income What bond rating carries the least risk?

L4

L3

ChaptChapter er 1111 •• Section Section 22

280

BackgroundEconomics in HistoryEconomics in HistoryThe Securities and ExchangeCommission (SEC) came into being aspart of the Securities Exchange Act of1934. The purpose of the act was toreform and regulate certain financialpractices, which many peopleblamed for the Great Depression.

The SEC’s mission is to preventfraud and deception in the purchaseand sale of stocks and bonds.Stockbrokers and companies thattrade in securities must register withthe SEC. Furthermore, any individualwho owns more than 10 percent of acompany’s stock is required to submitreports at regular intervals to the SEC.

Another important aspect of theSecurities and Exchange Act was togive the Federal Reserve authority toregulate margin requirements.Margin means the amount of moneythat an investor deposits with a bro-ker. Stock bought on margin isfinanced largely with credit. Buyingon margin was a popular way toinvest before the Great Crash in 1929.In fact, one reason the market col-lapsed was that so much of the stockin circulation had been bought withcredit. The Securities and ExchangeAct gave the Federal Reserve the rightto require that anyone who boughtsecurities on margin had to deposit aminimum amount of cash with a bro-ker before the rest of the purchaseprice could be financed.

Answer to . . . Building Key Concepts Studentsmay say Treasury bonds becausethey are backed by the federal government.Building Key Concepts They differmainly in their maturity and in theterm.

Have students read the section titled “Savings Bonds” and then answer the question below.Which of the following is not a characteristic of savings bonds?

A They are issued by the government.

B They can be used to help pay for public works projects.

C They are sold in low denominations.

D They carry a high risk.

Preparing for Standardized TestsPreparing for Standardized Tests��

On the other hand, bonds also pose twomain disadvantages to the issuer:

1. The company must make fixed interestpayments, even in bad years when it doesnot make money. In addition, it cannotchange its interest payments even wheninterest rates have gone down.

2. If the firm does not maintain financialhealth, its bonds may be downgraded toa lower bond rating and thus may beharder to sell unless they are offered at adiscount.

Types of BondsDespite these risks to the issuer, whencorporations or governments need toborrow funds for long periods, they oftenissue bonds. There are several differenttypes of bonds.

Savings BondsYou may already be familiar with savingsbonds, which are sometimes given to youngpeople as gifts. Savings bonds are low-denomination ($50 to $10,000) bondsissued by the United States government.The government uses funds from the saleof savings bonds to help pay for publicworks projects like buildings, roads, anddams. Like other government bonds,savings bonds have virtually no risk ofdefault, or failure to repay the loan.

The federal government pays intereston savings bonds. However, unlike mostother bond issuers, it does not send interestpayments to bondholders on a regularschedule. Instead, the purchaser buys asavings bond for less than par value. Forexample, you can purchase a $50 savingsbond for only $25. When the bondmatures, you receive the $25 you paid forthe bond plus $25 in interest.

Treasury Bonds, Bills, and NotesThe United States Treasury Departmentissues Treasury bonds, as well as Treasurybills and notes (T-bills and T-notes). Theseinvestments offer different lengths ofmaturity, as shown in Figure 11.6. Backedby the “full faith and credit” of the UnitedStates government, these securities areamong the safest investments in terms ofdefault risk. The federal governmenttemporarily stopped selling 30-year bondsin 2001, upsetting many investors who likesafe, long-term investments.

savings bondlow-denomination bondissued by the UnitedStates government

Treasury Bond Treasury Note

Term

Maturity

Liquidity andsafety

Minimumpurchase

Denomination

long-term intermediate-term

from 10 to 30 years from 2 to 10 years

safe safe

$1,000 $1,000

$1,000

Treasury Bill

short-term

3, 6, or 12 months

liquid and safe

$1,000

$1,000$1,000

Figure 11.6 Treasury Bonds, Notes, and BillsFigure 11.6 Treasury Bonds, Notes, and Bills

Treasury bonds, notes, and bills represent debt that thegovernment must repay the investor.Government How do these three types of governmentsecurities differ?

Figure 11.5 Average Bond Yields, 1992–2003Figure 11.5 Average Bond Yields, 1992–2003

Per

cent

yie

ld p

er y

ear

0

10

8

6

4

2

12

1998199719961995199419931992

Year

Source: Statistical Abstract of the United States, 1997 and 2004–2005

1999 2000 2001 2002 2003

Corporate bonds30-year Treasury bondMunicipal bonds

From the early 1990s to the start of the 2000s, bond yieldsdipped slightly for all three types of bonds shown.Corporate bonds, however, continued to have the highestyield. Income Which of the three types of bonds wouldyou expect to carry the least risk? Explain your answer.

PHSchool.com

Web Code: mng-4112

Have students use the followingmethod to take notes on this section.First have them draw a vertical linedown their paper, about one third ofthe way in from the left side. Havethem paraphrase important pointsfrom the section in the right column.Then, in the left column, ask them towrite questions that can be answeredby their notes. Explain to them thatthey can use these notes for reviewby covering up the right column witha sheet of paper and answering thequestions in the left column. LPR

(Reteaching) Have students identifythe types of bonds described in thissection (savings, Treasury, corporate,junk) in a poster, table, chart, orother graphic presentation. Displaythese projects on a bulletin board.

281

ChaptChapter er 1111 •• Section Section 22

Calculating Rate of Return Calculating interest ratesand rates of return can be tedious work.Fortunately, some calculators have been designedspecifically to handle interest rate calculations forboth simple and compound interest over varyinglengths of time. In addition, graphing calculatorscan be programmed to show data visually, enablingthe user to enter data and track the progress ofinvestments.

Making the Connection Ask students who owngraphing calculators to bring them in. You mayalso be able to borrow some from your school’smathematics department. Have a knowledgeablestudent demonstrate their use, or lead a classdemonstration with investment data.

Interdisciplinary Connections: MathInterdisciplinary Connections: Math

Municipal BondsState and local governments and munici-palities (government units with corporatestatus) issue bonds to finance suchimprovements as highways, state buildings,libraries, parks, and schools. These bondsare called municipal bonds, or “munis.”

Because state and local governments havethe power to tax, investors can assume thatthese governments will be able to keep upwith interest payments and repay the prin-cipal at maturity. Standard & Poor’s andMoody’s therefore consider most municipalbonds to be safe investments, dependingupon the financial health of a particularstate or town. In addition, the interest paidon municipal bonds is not subject to incometaxes at the federal level or in the issuingstate. Because they are relatively safe andare tax-exempt, “munis” are very attractiveto investors.

Corporate BondsAs you read in Chapter 8, corporationsissue bonds to help raise money to expandtheir businesses. These corporate bonds areissued in fairly large denominations, suchas $1,000, $5,000, and $10,000. Theinterest on corporate bonds is taxed asordinary income.

Unlike city and other governments, corpo-rations have no tax base to help guarantee

their ability to repay their loans, so thesebonds have moderate levels of risk. Investorsin corporate bonds must depend on thesuccess of the corporation’s sales of goodsand services to generate enough income topay interest and principal.

Corporations that issue bonds arewatched closely not only by Standard &Poor’s and Moody’s, but also by theSecurities and Exchange Commission (SEC).The SEC is an independent governmentagency that regulates financial markets andinvestment companies. It enforces lawsprohibiting fraud and other dishonestinvestment practices.

Junk Bonds Junk bonds, or high-yield securities, arelower-rated, and potentially higher-paying,bonds. They became especially popularinvestments during the 1980s and 1990s,

municipal bond a bondissued by a state orlocal government ormunicipality to financesuch improvements ashighways, statebuildings, libraries,parks, and schools

corporate bond a bondthat a corporationissues to raise moneyto expand its business

Securities andExchange Commissionan independent agencyof the government thatregulates financialmarkets and investmentcompanies

junk bond a lower-rated, potentiallyhigher-paying bond

� Municipal bonds, or munis, help finance localprojects such as libraries and schools.

L2

L3

You may wish to have students addthe following to their portfolios. Askthem to write a brief essay comparingand contrasting certificates of depositand money market mutual funds.Explain that their essays shoulddescribe the two types of financialassets and show how they are similarand different.

Economics Assessment RubricEconomics Assessment Rubrics folder,pp. 6–7 provides sample evaluationmaterials for a writing assignment.

Ask groups of three to four studentsto design graphic organizers that usetext and illustrations to show the dif-ferences and interrelationshipsamong capital markets, money mar-kets, primary markets, and secondarymarkets. Encourage students to gobeyond the text to find additionalinformation about these markets andincorporate that information intotheir graphic organizers.

ChaptChapter er 1111 •• Section Section 22

282

Answer to . . . Global Connections Students maypoint out that investments wouldnot be regulated by the U.S. govern-ment or that certain politicalevents, such as wars, could affect aninvestment negatively.Cartoon Caption Students may saythat junk bonds are not as worth-less as the cartoonist suggests.

Have students read the section titled “Certificates of Deposit” and then answer the ques-tion below.Why are certificates of deposit attractive to small investors?

A They cost as little as $100.

B They are insured by the Securities and Exchange Commission.

C They pay higher interest than money market mutual funds.

D They are highly rated by Standard & Poor’s.

Preparing for Standardized TestsPreparing for Standardized Tests��

when large numbers of aggressive investorsmade—but also sometimes lost—largesums of money buying and selling thesesecurities.

Junk bonds have been known to payover 12 percent interest at a time whengovernment bonds are yielding only about8 percent interest. On the other hand, junkbonds also carry bond ratings of “lowermedium grade” or “speculative” (BB, Ba,or lower). Investors in junk bonds thereforeface a strong possibility that some of theissuing firms will default on their debt.

Nevertheless, in many cases junk bondshave enabled companies to undertake activ-ities that would otherwise have been impos-sible to complete. (For more information onhow to follow the progress of a stock byreading stock market reports, see page 284.)

Other Types of Financial AssetsIn addition to bonds, investors may chooseother financial assets. These include certifi-cates of deposit and money market mutualfunds, as well as stock. You will read moreabout stock in Section 3.

Certificates of DepositCertificates of deposit (CDs) are one of themost common forms of investment. As youread in Chapter 10, CDs are availablethrough banks, which lend out the fundsdeposited in CDs for a fixed amount oftime, such as 6 months or a year.

CDs are attractive to small investorsbecause they cost as little as $100.Investors can also choose among manyterms of maturity. This means that if aninvestor foresees a future expenditure, suchas college tuition or a major homeimprovement, he or she can buy a CD thatmatures just before the expenditure is due.

Money Market Mutual FundsMoney market mutual funds are specialtypes of mutual funds. As you read inSection 1, businesses collect money fromindividual investors and then buy stocks,bonds, or other financial assets to form amutual fund.

In the case of money market mutualfunds, intermediaries buy short-term finan-cial assets. Investors receive higher intereston a money market mutual fund than theywould receive from a savings account. Onthe other hand, money market mutualfunds are not covered by FDIC insurance.(As you read in Chapter 10, FDIC insur-ance protects bank deposits up to $100,000per account). This makes them slightlyriskier than savings accounts.

� From what you have read, how accurate is the cartoonist’sview of junk bonds?

International Bonds The United States government isn’t the onlygovernment that issues bonds. Many other countries, including Saudi Arabia,Germany, and Japan, also issue bonds. International bonds are usually issuedin large denominations, starting at $1 million. In addition, principal and couponpayments are often made in foreign currencies. The investors, therefore,cannot know what the value of payments will turn out to be. What are twodrawbacks to buying international bonds?

Global Connections

L4

L3

Guide to the EssentialsChapter 11, Section 2, p. 47 providessupport for students who need addi-tional review of the section content.Spanish support is available in theSpanish edition of the guide on p. 47.

Quiz Unit 4 folder, p. 16 includesquestions to check students’ under-standing of Section 2 content.

Presentation Pro CD-ROMQuiz provides multiple-choice

questions to check students’ under-standing of Section 2 content.

Answers to . . .

Section 2 AssessmentSection 2 Assessment1. Investors earn money from interest

on the bonds they buy. They canalso earn money by buying bonds ata discount and cashing them inonce they reach maturity.

2. Bond ratings give investors an indi-cation of the quality or degree ofdefault risk that various bonds carry.

3. Savings bonds are low-denomination($50 to $10,000) bonds issued by theU.S. government. They involve littlerisk. Treasury bonds are bondsissued by the Treasury Department.They are safe investments, and theirinterest is exempt from state andlocal taxes. Municipal bonds areissued by state or local govern-ments to help finance local improve-ments, are generally safeinvestments, and carry the addedbonus that their interest is free fromfederal income tax. Corporatebonds are issued by corporations toraise large sums of money andinvolve moderate risk. Junk bondsare lower-rated, potentially higher-paying bonds issued by particularfirms.

4. Capital markets include marketswhere money is lent for periodslonger than one year (long-termCDs, corporate and governmentbonds). Money markets includemarkets where money is lent forperiods of less than a year (short-term CDs, Treasury bills, moneymarket mutual funds).

GTE

283

ChaptChapter er 1111 •• Section Section 22

5. $20 in interest6. Answers will vary with students’ personal prefer-

ence and familiarity with various investments.Students who prefer very safe investments maychoose a certificate of deposit or a savings bond.Other students may choose money market funds fora higher return.

7. The AAA bond will generally be more expensivebecause of its lower risk.

8. Students should create a fact sheet showing accurate information about bonds and their characteristics.

Financial Asset MarketsFinancial assets, including bonds, certifi-cates of deposit, and money market mutualfunds, are traded on financial asset markets.The various types of financial asset marketsare classified in different ways.

Capital and Money MarketsOne way to classify financial asset marketsis according to the length of time for whichfunds are lent. This type of classificationincludes capital markets and moneymarkets.

• Capital markets Markets in whichmoney is lent for periods longer than ayear are called capital markets. Financialassets that are traded in capital marketsinclude long-term CDs and corporateand government bonds that require morethan a year to mature.

• Money markets Markets in whichmoney is lent for periods of less than ayear are called money markets. Financialassets that are traded in money marketsinclude short-term CDs, Treasury bills,and money market mutual funds.

Primary and Secondary MarketsMarkets may also be classified according towhether assets can be resold to otherbuyers. This type of classification includesprimary and secondary markets.

• Primary markets Financial assets thatcan be redeemed only by the originalholder are sold on primary markets.Examples include savings bonds, whichare non-transferable (that is, the originalbuyer cannot sell them to anotherbuyer). Small certificates of deposit arealso in the primary market becauseinvestors would most likely cash them inearly rather than try to sell them tosomeone else.

• Secondary markets Financial assets thatcan be resold are sold on secondarymarkets. This option for resale providesliquidity to investors. If there is a strongsecondary market for an asset, theinvestor knows that the asset can beresold fairly quickly without a penalty,thus providing the investor with readycash. The secondary market also makespossible the lively trade in stock that isthe subject of the next section.

capital market marketin which money is lentfor periods longer thana year

money market marketin which money is lentfor periods of less thana year

primary market marketfor selling financialassets that can only beredeemed by theoriginal holder

secondary marketmarket for resellingfinancial assets

Section 2 Assessment

Key Terms and Main Ideas1. Describe two ways in which investors can earn money

from bonds.2. Why are bond ratings useful to investors?3. Describe five different types of bonds.4. How do capital markets and money markets differ?

Applying Economic Concepts5. Math Practice Suppose that you buy a bond for $100

that pays 4 percent interest per year. How much moneywill you have earned when the bond reaches maturity infive years?

6. Decision Making Suppose that you have saved $1,000.In which of the financial assets described in this sectionwould you invest? Explain your choice.

7. Critical Thinking Which bond would you expect to bemore expensive, a bond with a AAA rating or a bond witha BBB rating? (Assume that both bonds pay the samerate of interest.)

8. Try This Assume that you are an investment advisorwith a client who is interested in buying bonds. Create afact sheet that shows your client the different types ofbonds and their characteristics.

PHSchool.com

For: Math ActivityVisit: PHSchool.comWeb Code: mnd-4112

Progress Monitoring OnlineFor: Self-quiz with vocabulary practiceWeb Code: mna-4116

Typing in the Web Codewhen prompted will bring students directlyto detailed instructions for this activity.

Progress Monitoring OnlineFor additional assessment, have students accessProgress Monitoring Online at Web Code: mna-4116