Chapter 15: Investing in Bonds
Treasury notes (T-notes)
$100 dollar units with maturity of 1-10 years interest paid every 6 months until maturity higher rate than T bill can be sold before maturity
What can effect bond prices:
1) Actions by Federal Reserve can effect interest rates for new bond issues 2) interest rates for new bond issues fluctuating affects amount annual income you will recieve if purchase new bonds 3) interest rate fluctuation casue current market value of older bonds to fluctuate until maturity 4) value of bond may affect financial condition of company/gov entity issuing the bond, factors of supply and demand, change in economy, and proximity of bond maturity
Corporation advantages of corporate bonds
1) Interest rate is 1-2% lower than noconvertible 2) conversion feature attracts investors interested in speculative gains that conversion to common stock provides 3) if investor converts, coroporation no longer has to redeem bond at maturity
Options if you own a bond
1) hold on until maturity 2) sell to another investor
What three reasons do investors purchase corporate bonds for?
1) interest income 2) possible increase in value 3) repayment at maturity
bond ratings
AAA, AA - high grade A, BBB, BBB- - medium BB+, BB, B - speculative CCC, CC, C, D - problematic or default
What if you are worried about municipal bond default?
Can get them insured but these may also be callable
Current yield on T bill
Discount/purchase price $10/990 = 1.01%
Taxable equivalent yield
Tax exempt return / (1.0 - your tax rate) if you have 3% tax exempt municipal bond and you are in 24% tax bracket .03/.76 = 3.95%
What five principal securities does the US gov offer?
Treasury bills Treasury notes Treasury bonds Treasury Inflation Protected Securities (TIPS) US gov savings bonds All purchased through Treasury direct, which conducts auctions of these securities
call feature
allows corporation to cal in/buy outstanding bonds from current bond holders before maturity usually corp pays premium above face value of bond when they do this
current yield on corporate bond
annual income amount/current market value face value = $1000 bond pays 2.85%, maturity in 2024 current market price is $970 = $28.50/$970 = 2.94%
general obligation bond
backed by full faith, creidt, unlimited taxing power of gov that issued it
debenture
bond or debt instrument that is backed by the reputation of the issuing company if corporation defaults on interest payment/repayment at maturity, then investors with debentures become general creditor's, like firms suppliers if goes bankrupt, can claim any asset not specifically used for collateral
serial bonds
bonds of a single use that mature on different dates in 20 year period, no bond matures in first ten years. Then 10% of the total bond # will mature until all bonds paid off
mortgage bond
corporate bond secured by various assets of issuing firm safer than debenture because corporate assets/collateral can be sold to repay bondholders if there is a default used to appeal to conservative investors interest rates lower than unsecured debenture
High-yield bond
corporate bonds that pay higher interest but also have higher risk of default aka junk bonds
corporate bond
corporation's pledge to repay specified amount of money with interest
Total return
current return + capital gain
maturity date
date which corp. repays borrowed money 1-30 years after date of issue
municipal bond
debt security issued by state/local gov offered through brokerages or direct gov agency
Approximate market value
dollar amount annual interest/ comparable bond interest rate if you have $1000 bond that pays 3.45%, but comparable bonds have interest at 4% then =34.50/.04 = $862.50 is the value of your bond
face value or par value
dollar amount bond holder wil recieve at maturity date
Why do corps sell bonds?
dont have enough money for major purchases Need to finance on-going business activities find difficult/impossible to sell stock want to improve corp leverage- use of borrowed funds to increase firm's return on investment use interest
convertible bond
exchanged at the owner's option for specified number if shares of common stock. interest rate 1-2% lower than traditional bond
Bond price calculation
face value * bond quote if price quote is 98 for a $1000, the actual price is $980: 1000*0.98 = 980
Dollar amount of annual interest
face value * interest rate
trustee
financially independent firm that acts as the bondholders' representative commercial bank or other institution brings legal action in bondholders' interest if corp does not meet standards stipulated in indenture
sinking fund
fund to which annual or semiannual deposits made for purpose of redeeming bond annual/semiannual deposits made to redeem bond issue forces corp to make arrangements of bond repayment before maturity if terms of provision not met, trustee/holder can take legal action
Tax caveat of US securities
interest subject to federal, but not local or state, taxes
Treasury bond
issued in $100 increments, have 30 year maturity interest paid every 6 months until maturity can also be sold before maturity paid face value at maturity
convertible corporate note
legal debt convertible to shares of common stock at the investor's option lower risk corporate bond but have speculative advantage with common stock
bond indenture
legal document that details all conditions relaed to bond issue
Treasury bill (T-bell)
minimum unit of $100 with additional increments above $100 minimum maturity few days - year discounted securities where you pay less than maturity value if T bills have maturity value of $1000, and interest rate 1%, their initial price is $990
Bearer bond
not registered in investor's name anyone who holds the bond, rightful owner or not, can trade it for the principal and interest at maturity I.E. the plot motivation of "Die Hard"
debt securities
offered by federal agencies/enterprises like Fannie Mae, Ginnie Mae, Freddie Mac - Mortgage/loan based agencies
asset allocation
porcess of spreading money among different types of investments to lower risk
book entry
process of recording ownership of bonds electronically by central depository, custodian, or brokerage firm
Types of bond payment methods based on bond type:
registered bonds, registered coupon bond, bearer bond
Registerd coupon bond
registered for [principal only, not for interest registered owner collects principal at maturity, but anyone holding one of its detachable coupons may present to be paid part of the interest
registered bond
registered in the owner's name by the issuing company check sent directly to holder
revenue bond
repaid from income generated by project it is designed to finance
Methods for ensuring corp can meet a bond issue
sinking fund and serial bonds
Treasury Inflation-Protected Securities (TIPS)
sold minimum units $100 with add increments 5-, 10-, 30- year maturities when TIPS mature, paid either original or adjusted principal, which ever is greater pay interest twice ayear at fixed rate; interest payments rise with inflation, fall with deflation can hold/sell before maturity
bond ladder
strategy where investors divide investment dollars among bonds that mature at regular intervals in order to balance risk and return buy ranfe if bonds that mature at different years 1-10, in 1 year increments. When one bond matures, buy another 10 year bond. The shorter bonds have higher stability since do not fluctuate much to changing interest rates. long term provides higher return and accept risk tyhay longterm maturity might change
yield to maturity
takes into account relationship among bond's maturity value, time to maturity, current price, dollar amount interest (dollar amount interest + ((face value - market value)/number periods) then divide that number by (market value + face value)/2
subordinated debenture
unsecured bond that gives holders claim secondary to that of mortgage and debenture holders with respect to interest payments, repayments, assets. Higher interests rates because of increased risk
government bond
written pledge by gov/municipality that repay at specified sum money + interest
