Chapter 15
Investing in Bonds
Chapter 15
Learning Objectives
 Describe the characteristics of corporate bonds
 Discuss why corporations issue bonds
 Explain why investors purchase corporate bonds
 Discuss why federal, state, and local governments
issue bonds, and why investors purchase
government bonds
 Evaluate bonds when making an investment
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Characteristics of Corporate Bonds
Objective 1: Describe the characteristics of corporate
bonds
 Corporation’s written pledge to repay a specified amount of
money with interest
 The face value is the dollar amount that the bondholder will
receive at the bond’s maturity date-usually $1,000
 Bondholders receive interest payments every six months at the
stated interest rate
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Characteristics of Corporate Bonds
•Par value = $1,000
•Coupon = 6.5% of par value per year,
or $65 per year ($32.50 every six months).
•Maturity = 27 years (matures in 2036)
•Issued by AT&T.
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Characteristics of Corporate Bonds
 The legal conditions are described in a bond
indenture
 A trustee is a financially independent firm that acts
as the bondholder’s representative
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Characteristics of Corporate Bonds
Risks of bonds
 Interest risk
 Purchasing power risk
 Business risk
 Liquidity risk
 Call risk
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Characteristics of Corporate Bonds
Four important features:
 Interest rate increases, bond value decreases
 Market value of bond will be less than the par
value if investor’s required rate is above the
coupon interest rate
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Characteristics of Corporate Bonds
Four important features:
 As maturity date approaches, the market value of
bond approaches its par value
 Long-term bonds have greater interest rate risk
than do short-term bonds
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Why Corporations Sell Bonds
Objective 2: Discuss why corporations issue bonds
 To get funds for major purchases
 To fund ongoing business activities
 When it is difficult or impossible to sell stock
 To improve financial leverage
 Interest paid to bondholders is a tax deductible business
expense that can be used to reduce the federal and state
taxes corporations must pay
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Why Corporations Sell Bonds (continued)
TYPES OF BONDS
 Debenture bond
 Most corporate bonds are debenture bonds
 Unsecured - backed only by the reputation of the
issuing company
 Mortgage bond
 A corporate bond that is secured by various assets
of the issuing firm, usually real estate
 Interest rate is lower because it is secured by the
collateral and corporate assets
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Why Corporations Sell Bonds (continued)
 Subordinated debenture bond
 An unsecured bond that gives bondholders a claim
secondary to that of other designated bond holders
with respect to interest payments and claim on
assets
 Convertible bond
 A special kind of corporate bond that can be
exchanged, at the owner’s option, for a specified
number of shares of the corporation’s common
stock
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Why Corporations Sell Bonds (continued)
PROVISIONS OF REPAYMENT
 Call Feature
 Corporation can call in or buy back outstanding
bonds from current bondholders before the maturity
date
 Most agree not to call bonds for the first 5 to 10 years
after they are issued
 Bonds called, if their interest rate is much higher
than the going rate
 Most corporate bonds are callable
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Why Corporations Sell Bonds (continued)
 Sinking fund
 Corporations deposit money in this fund annually
or semiannually and use the money to pay off the
bondholders when the bond issue comes due
 Serial bonds
 Bonds of a single issue that mature on different
dates
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Why Investors Buy Corporate Bonds
Objective 3: Explain why investors purchase
corporate bonds

Interest Income
 Investors receive interest every six months
 Interest will be paid to investors twice a year, with
the payment based on the interest rate and the
face value of the bond
 Registered bonds, Bearer bonds, Zero-coupon
bonds

Dollar Appreciation of Bond Value
 May be able to sell the bond to someone else at a
higher price if the interest rate on the bond is
higher than the market rate

Bond face amount will be repaid at maturity
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Why Investors Buy Corporate Bonds
(continued)
THE MECHANICS OF BOND TRANSACTION
 Bonds can be held until maturity or sold in the secondary
market
 Most bonds sold through full-service brokerage firms,
discount brokerage firms, or the Internet
 Corporate bonds may be purchased in the primary
market or secondary market
 Generally a minimum commission of $10-$35 on a $1,000
bond
 Interest and capital gains from selling bonds are both
taxable
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Government Bonds
and Debt Securities
Objective 4: Discuss why federal, state, and local
governments issue bonds, and why investors
purchase government bonds
 Sold to obtain money to finance the national debt,
and the ongoing costs of government
 Three levels of government issue bonds:
 Federal-no state income tax on the interest
 State
 Local municipalities
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Government Bonds and Debt Securities
TREASURY BILLS, NOTES, AND BONDS
Treasury Bills (T-Bills)
 $100 minimum
 4, 13, 26, or 52 weeks to mature
 Sold at a discount
Treasury Notes (T-Notes)
 $100 units
 2, 5, and 10 year terms
 Interest paid every six months
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Government Bonds and Debt Securities
(continued)
Treasury Bonds
 Issued in minimum units of $100
 Have maturities of 30 years
 Interest rates are generally higher than those of Tbills and T-Notes
 Interest is paid every 6 months
 Held until maturity or sold before maturity
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Government Bonds and Debt Securities
(continued)
FEDERAL AGENCY DEBT ISSUES
 Fannie Mae ( www.fanniemae.com)
 Federal National Mortgage Association
 Ginnie Mae - pay interest once a month
 Government National Mortgage Association
 Freddie Mac
 Federal Home Loan Mortgage Corporation
 Slightly higher risk than Treasury securities, so slightly
higher interest rates
 Issued for 1-30 years, 12 year average
 Minimum denominations may be as high as $10,000-
$25,000
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Government Bonds and Debt Securities
(continued)
STATE AND LOCAL GOVERNMENT SECURITIES
 General obligation bonds are backed by the state or
local government that issues them
 Revenue bonds are repaid from money generated by the
project the funds finance, such as a toll bridge
 Municipal bonds or munis
 Issued by a state or local government, such as cities,
counties, school districts
 Use funds for ongoing costs & to build major projects such
as schools, airports, and bridges
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Government Bonds and Debt Securities
(continued)
Features of Municipal Bond
 People like to invest in projects
close to home
 They like insured municipal bonds,
or states that guarantee payment
 May be callable, but usually not until after the first
ten years
 Interest earned may be exempt from federal income
tax so yield is higher
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Government Bonds and Debt Securities
(continued)
Taxable equivalent yield=
Example:
Taxable equivalent yield =
Tax-exempt yield
1.0 - Your tax rate
.06
1.0 - 0.28
= 0.083 = 8.3%
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The Decision to Buy or Sell Bonds
Objective 5: Evaluate bonds when making an
Investment
THE INTERNET
 The Internet can be used in the following ways to evaluate
a bond
 Obtain the price information
 Trade bonds online for a lower commission
 Research information on the corporation and bond
issues online
 Some relevant Websites are:
www.bondsonline.com
www.buysellbonds.com
www.municipalbonds.com
www.emuni.com
www.fmsbonds.com
www.investiginbonds.com
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The Decision to Buy or Sell Bonds (continued)
ANNUAL REPORTS
 Write or telephone the corporation to receive the
annual report
 Corporations maintain web site that provides access
to annual reports
 Some financial publications provide a reader’s
service to request an annual report
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The Decision to Buy or Sell Bonds (continued)
BOND RATINGS
 Bond ratings provide quality and risk associated with
bond issues
 Moody’s Investor Service Inc. and Standard & Poor’s
Corporation
 Bond ratings generally range from AAA to D
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The Decision to Buy or Sell Bonds (continued)
BOND YIELD CALCULATIONS
 Yield is the rate of return earned by an investor who
holds a bond for a stated period
Current yield on corporate bond = Annual income amount
Current market value
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The Decision to Buy or Sell Bonds (continued)
 Yield to maturity
-- The rate of return investors earn on a bond if they hold it
to maturity.
 Suppose we paid $898.90 for a $1,000 par 10% coupon bond
with 8 years to maturity and semi-annual coupon payments.
What is our yield to maturity?
 N = 16, PV = -898.9
PMT = 50 FV = 1000
 Solve I% = 6%
 6% * 2 = 12%
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Online Activity
Go to one of these sites and look up
information about municipal bonds in your
area.
www.emuni.com
www.munidipalbonds.com
…What do you think of the rates these bonds
are paying?
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