CH15: Investing in Bonds

Municipal Bonds

Bonds issued by state and local governments are called_____ bonds

Registered bond

A type of bond. This bond's owner is recorded on the books of the issuer, and it can be transferred to another owner only when endorsed by the registered owner. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Bond ladder

A type of investing strategy. It consists of investors dividing their investment dollars among bonds that mature at regular intervals in order to balance risk and return. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Annual report

A yearly-written financial statement that provides an overall summary of a corporation's fiscal performance; it is prepared largely for the review of persons outside that corporation. A bondholder can obtaining a corporation's ___ ___ either by writing or telephoning (calling) the corporation to receive the ___ ___, OR by logging on to the corporation's Web Site, which usually provides and maintains access to their ___ ___. This term describes how the corporation performed in the last year (shows income earnings, assets, and liabilities), and is required to be issued to the corporation's shareholders. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Junk

Corporate bonds with low or no investment rating, called____ bonds are risky and speculative

Agency debt

Debt obligations of agencies of the federal government. The can be in the form of notes or bonds issued at face value and carry a stated interest rate payable semi-annually, and are often called "Indirect Debt." This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

face value

amount a bondholder is repaid when a bond matures

junk

corporate bonds with low or no investment rating, called __________ bonds, are risky and speculative

mortgage

secured bonds, called ___________, are backed by the specific assets of the issuing firm

Fluctuate

Bond prices tend to ______ as much as if not more than stock prices

Stated interest rate

Bondholders receive ___ payments every six months. This term is one of the characteristics of corporate bonds (Objective 1).

Fixed income investments

Bonds are considered_____ investments because a specified amount of interest is paid on a regular basis

Consumer price index

A ___ ___ ___ that is determined by measuring the price of a standard group of goods meant to represent the market basket of a typical urban consumer. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Callable

A bond is_______ when it can be paid off before its maturity date

Debt security

A contract that promises to pay a given amount of money to the owner of the security at specific dates in the future. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Corporate bond

A corporation's written pledge to repay a specified amount of money with interest.

Freddie Mac

A federal agency debt issue. The term itself is a loose acronym for the Federal Home Loan Mortgage Corporation, and they recently went seriously bankrupt (but was bailed out by the U.S. Government). This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Fannie Mae

A federal agency debt issue. Their Web Site is http:/www.___.com, the term itself is a loose acronym for the Federal National Mortgage Association, and they recently went seriously bankrupt (but was bailed out by the U.S. Government). This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Ginnie Mae

A federal agency debt issue. They pay interest to their bondholders once per month, the term itself is a loose acronym for the government National Mortgage Association, and they recently went seriously bankrupt (but was bailed out by the U.S. Government). This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Trustee

A financially independent firm that acts as the bondholder's representative. This term is one of the characteristics of corporate bonds (Objective 1).

Brokerage firm

A stock broker's business. It charges a fee to act as intermediary between buyer and seller. This term is one of the reasons why investors purchase corporate bonds (Objective 3)

Treasury Bills (T-Bills)

A type of bond (but NOT a type of corporate bond), specifically a type of government bond and/or debt security. They are all sold at a minimum price of $100, take 4, 13, 26, or 52 weeks to fully mature, and are sold at a discount. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Treasury bonds

A type of bond (but NOT a type of corporate bond), specifically a type of government bond and/or debt security. They are issued in minimum units of $100, are sold in 30-year maturities, have interest rates that are generally higher than those of T-bills and T-notes, have bondholders pay their interest every 6 months (semiannually), can be either held until maturity OR sold before maturity, usually are sold in blocks of 10,000 bonds, and China issues a lot of them. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Treasury Notes (T-Notes)

A type of bond (but NOT a type of corporate bond), specifically a type of government bond and/or debt security. They are sold in $100 units, are sold in either 2-, 3-, 5-, 7-, or 10-year terms, and bondholders pay interest on this type of bond every six months (semiannually). This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Treasury Inflation Protected Securities (TIPS)

A type of bond (but NOT a type of corporate bond), specifically a type of government bond and/or debt security. This type of bond is sold in minimum units of $100, are sold in either 5-, 10-, or 30-year terms, are valued based upon the consumer price index, have bondholders pay their interest every 6 months (semiannually, but it can vary), and can either be held until maturity OR sold before maturity. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Local municipality bond

A type of bond (but NOT a type of corporate bond), specifically a type of government bond. Most ___ communities and school districts across the U.S. issue this type of bond. An example of a ___ community and a school district that issue this kind of bond are the City of Madeira and Madeira City Schools. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Federal bond

A type of bond (but NOT a type of corporate bond), specifically a type of government bond. This type of bond has no state income tax on the interest, and is issued by the highest level of the U.S. government. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

State bond

A type of bond (but NOT a type of corporate bond), specifically a type of government bond. This type of bond is issued by all U.S. ___, and might not require the bondholder to pay taxes on them. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

General obligation bonds

A type of bond (but NOT a type of corporate bond), specifically a type of state and local government securities). This type of bond is backed by the state or local government that issues them. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Revenue bonds

A type of bond (but NOT a type of corporate bond), specifically a type of state and local government securities). This type of bond is repaid from money generated by the project the funds finance (such as a troll bridge. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Municipal bonds (munis)

A type of bond (but NOT a type of corporate bond), specifically a type of state and local government securities. This type of bond is issued by a state or local government (such as cities, state counties, or school districts), ans use the funds invested from bondholders in order to pay for ongoing costs and to build major projects (such as schools, airports, or bridges). Two subtypes of this type of bond are general obligation bonds and revenue bonds. The features of this type of bond are: People like to invest in projects close to home, they are insured (meaning states guarantee repaying them in payments to the bondholders; this means this type of bond is generally NOT high-risk), and the interest earned from this type of bond may be exempt from the federal income tax so that the yield would be higher (but it depends on the use of the given funds) This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Government bonds

A type of bond (but NOT a type of corporate bond). This type of bond is sold in order to obtain money to finance the national debt and the general ongoing costs of government. There are three levels of this type of bond: federal, state, and local municipalities. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Convertible bond

A type of bond, specifically a special kind of corporate bond. It can be exchanged at the owner's option for a specified number of shares of the corporation's common stock. This term is one of the reasons why corporations issue bonds (Objective 2).

Mortgage bond

A type of bond, specifically a type of corporate bond. It is secured by various assets of the issuing firm (usually real estate). Its interest rate is lower than other types of bonds because it is secured by collateral and specific corporate assets. This term is one of the reasons why corporations issue bonds (Objective 2).

Sinking fund

A type of bond. Corporations deposit money into this fund annually or semiannually, and use the money made to pay off the bondholders when this bond issue (order) comes due. This term is one of the reasons why corporations issue bonds (Objective 2).

Subordinated debenture bond

A type of bond. It is unsecured, and gives bondholders a secondary claim to that of mortgage of debenture bondholders with respect to interest payments and a claim on assets. This term is one of the reasons why corporations issue bonds (Objective 2).

High yield bond

A type of bond. It pays a higher rate of interest, but has a higher risk of default than most other types of bonds. This term is one of the reasons why corporations issue bonds (Objective 2).

Debenture bond

A type of bond. Most corporate bonds are this, and they are unsecured (they are backed only by the reputation of the issuing company). This term is one of the reasons why corporations issue bonds (Objective 2).

Serial bonds

A type of bond. These bonds consist of a single issue (order) that has different bonds within the same issue mature on different dates. This term is one of the reasons why corporations issue bonds (Objective 2).

Zero-coupon bond

A type of bond. This bond is issued at a deep discount from its value at maturity and pays no interest to the bondholder at all during the life of this bond. They are considered cheap, safe, and secure, and can be withdrawn before maturity with no withdrawal fee. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Bearer bond

A type of bond. This bond is not entitled to any bondholder (it is unregistered). They have a series of small, detachable coupons (in the form of paper flaps) that border the bottom of the bond certificate itself. On an annual basis, one of the coupons is cut or "clipped" from the bond and taken to a banking institution that is one of the listed paying agents. The elderly often buy these bonds because they do not issue interest to their bondholders. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Registered coupon bond

A type of bond. This bond is registered in the owners name for the face value only and not for interest. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Tax exempt

An investment is ____ when there is no tax due, either now or in the future

Tax deferred

An investment is _______ when income is taxed at a later time

Call feature

An option for a corporation that involves the corporation to call in or buy back outstanding bonds from their current shareholders before the maturity date. Most agree not to participate in this option for the first 5 to 10 years after bonds are issued from a corporation. Bonds are typically bought back if their interest rate is much higher than the going rate. Most bonds have this buying back option. This term is one of the reasons why corporations issue bonds (Objective 2).

Dollar Appreciation of Bond Value

An option for most bonds. It involves the bondholder possibly being able to sell his or her bond(s) to another bondholder at a higher price, but only if the interest rate on the bond(s) is higher than the market rate. The dollar amount in bold face will be repaid at the bond's maturity? This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Federal agency debt issues

An organization that manages government bonds. Examples of these are Fannie Mae, Ginnie Mae, and Freddie Mac. They have a slightly higher risk than Treasury securities (and thus slightly higher interest rates), are issued for 1-30-year terms (with a 12-year term being the average), have their minimum denominations possibly being as high as $10,000-$25,000, and their agency debt is callable before maturity. This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Zero coupon

An___ _bond is a type of bond that is sold for below its face value , with no interest payments, and redeemable for its face value at maturity

General Obligation

An____ bond is backed by the full faith and credit of issuing governmental unit.

Registered

An____ bond is recorded in the owners name by the issuer

Convertible

An_____ bond can be exchanged for a specified number of shares of common stock

Revenue

An_____ bond is repaid from the income generated by the project it is designed to finance.

Debenture

An_____ is a bond backed only by the reputation of the issuing corporation

Coupon

An____or bearer bond is not registered in the owners name by the issuer

Investment Grade

High-quality bonds are _____ because they are considered safe, stable and dependable

Secondary market

Market in which existing (not new) stocks and bonds are sold to the public. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Fitch

One of the many corporations that provide bond ratings. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Moody's

One of the many corporations that provide bond ratings. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Standard & Poor

One of the many corporations that provide bond ratings. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Mortgage Bond

Secured bonds, called______ are backed by specific assets of the issuing firm

ROI

The _____ is determined by dividing the annual interest dollar amount of a bond by its current market price

Face Value

The amount a bondholder is repaid when a bond matures is called_____?

Rate of return

The annual growth or increase in value of an investment expressed as a percentage of the amount of money that is invested. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Capital gains

The difference in value (profit) between what you originally paid for an investment and the price at which it was sold, assuming the investment gained value. This term is one of the reasons why investors purchase corporate bonds (Objective 3)

Approximate Market Value

The dollar amount of a given bond's annual interest/comparable interest rate. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Face value

The dollar amount that the bondholder will receive at the bond's maturity date; it is usually $1,000. This term is one of the characteristics of corporate bonds (Objective 1).

Maturity date

The exact date the issuer of a bond must pay the principal to the bondholder. This term is one of the characteristics of corporate bonds (Objective 1).

Par value

The face value of a bond. This term is one of the characteristics of corporate bonds (Objective 1).

Relevant bond-buying Web Sites

The following are ___ ___ ___ ___ for the purchase of bonds: Http://www.bonds-online.com, http://www.buysellbonds.com, http://www.municipalbonds.com, http://www.investinginbonds.com, http://www.emuni.com, and http://www.fmsbonds.com. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Bond indenture

The legal conditions of a bond are described in this document. This term is one of the characteristics of corporate bonds (Objective 1).

Yield to maturity

The measure of a bond's interest rate that will be earned assuming the bond is held to maturity. The formula for this term is: ((Dollar amount of annual interest) + ((Face value of bond - Market value of bond) / (Number of financial periods))) / ((Market value of bond + Face value of bond) / (2)). This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Commission

The payment made by insurers to agents or brokers for the sale and service of policies. This term is one of the reasons why investors purchase corporate bonds (Objective 3)

Annual interest rate/comparable interest rate

The percent of the principal you pay or earn per year. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Maturity

The principal of a bond must be repaid in full on its_____ date.

Bond yield (yield)

The rate of return that is earned by an investor who holds a bond for a stated period. The formula for this term is: (Annual income amount from bond) / (Current market value of bond(s). This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

The Internet

The term given to a world wide network of computers, through which people can exchange information. This term can be used in the following ways to evaluate a bond: to obtain the price information of a bond (the bid, ask, face value, etc.), to trade bonds online for a lower commission, and to research information on the corporation or on government bond issues online. This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Taxable equivalent yield

The yield a particular investor must earn on a taxable bond to have the same after-tax return they would receive from a particular tax-exempt issue. Formula for this term: (Tax-exempt yield) / (1.0 - your tax rate). This term is one of the reasons why federal, state, and local governments issue bonds, and/or one of the reasons why investors purchase government bonds (Objective 4).

Bond ratings

These provide a system on "grading" the quality and risk associated with bond issues. Examples of independent corporation that provide ___ ___ are Moody's Investor Service, Inc., Standard & Poor's Corporation, and Fitch. ___ ___ generally range from a grade of "AAA" (the best and highest rating) to "D" (the worst and lowest rating). This term is one of key factors in evaluating bonds when making an Investment (Objective 5).

Interest income

This is computed by multiplying the interest rate by the face value of a given bond. Investors receive this every six months. Registered bonds, registered coupon bonds, bearer, bonds, and zero-coupon bonds are all have this feature. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Discount

When bonds sell for less than their face value, they are selling at_____

Premium

When bonds sell for more than their face value, they are selling at a_______

Premium

When the par value of a bond is higher than the bond's face value. This term is one of the characteristics of corporate bonds (Objective 1).

Discount

When the par value of a bond is lower than the face value. This term is one of the characteristics of corporate bonds (Objective 1).

convertible

a __________ bond can be exchanged for a specified number of shares of common stock

registered

a ___________ bond is recorded in the oner's name by the issuer

zero coupon

a ____________ bond is a type of bond that is sold below its face value, with no interest payments, and redeemable for its fave value at maturity

debenture

a ____________ is a bond backed only by the reputation of the issuing corporation

coupon

a ____________ or bearer bond is not registered in the owner's name by the issuer

general obligation

a ______________ bond is backed by the full faith ad credit of the issuing governmental unit

revenue

a _______________ bond is repaid from the income generated by a project it's designed to finance

callable

a bond is __________ when it can be paid off before it's maturity date

fixed income

bonds are considered __________ investments because a sepcified amount of interest is paid on a regular basis

municipal

bonds issued by state and local governments are called _____________ bonds

investment

high-quality bonds are ________ because they are considered safe, stable, and dependable

maturity

the principal of a bond must be repaid in full on its ________ date

discount

when bonds sell for less than their fave value, they are selling at a _______________

premium

when bonds sell for more than their face value, they are selling at a _______________

The mechanics of a bond transaction

• Bonds can be held until maturity or sold in the secondary market • Most bonds are sold through full-service brokerage firms, discount brokerage firms, or the Internet • Generally, a minimum commission of $5-$35 is charged on a $1,000 bond • Interest and capital gains from selling bonds are both taxable for the bondholder. This term is one of the reasons why investors purchase corporate bonds (Objective 3).

Reasons why corporations issue bonds (Objective 2)

• To get funds for a corporation's major *P*urchases • To get ongoing *B*usiness *A*ctivities • When it is *D*ifficult or impossible for a corporation to Sell Stock • To improve a corporation's financial *L*everage • Interest paid to bondholders is a *T*ax *D*eductible business expense that can be used to reduce the federal and state taxes corporations must pay (Note: a bondholder purchasing bonds is NOT a tax deductible activity) P BA DSS, L TD