Bonds & Mutual FundsChapter 10

Bonds

• Two types • Corporate• Government

• What is a bond• Essentially bondholder (investor) loaning

money to a corporation or government entity

Why Issued

• Corporations• Way to raise $$ when it is difficult or

impossible to sell stock

• Government• To help fund its regular ongoing activities• Fund major projects

Types of Corporate Bonds

• Debentures

• Mortgage

• Subordinated Debentures

• Convertible Bonds

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

Mortgage Bonds

• Also known as a secured bond

• Backed by assets of the corporation

• Less risk than a debenture

• Lower return

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

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

How Repaid

• Premiums• 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

Why Buy

• Safe investment – relatively risk free

• Provide interest income

• May increase in value

• Face value repaid when reaches maturity

How Interest Paid

• Usually paid every 6 months

• Methods• Registered bonds• Coupon bonds• Bearer bonds• Zero-coupon bonds

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

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

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

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

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

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

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

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

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

• http://www.savingsbonds.gov

Mutual Funds

• Mutual Fund Scavenger Hunt

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

Types of Mutual Funds

• Closed-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

Types of Mutual Funds

• 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

Fees and Other Charges

• Management 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

Capital Gain vs Capital Gain Distribution

• Capital Gain• 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

Making Informed Decisions

• Newspapers

• Prospectuses

• Annual Reports

• Financial Publications

• Professional Advice

• Internet

Categories of Mutual Funds

• Stock Mutual Funds

• Bond Mutual Funds

• Mixed Mutual Funds