BONDS
Savings
and
Investing
Characteristics of Bonds
• Bonds are debt instruments offered by the
federal, state or local government and
corporations
• Bonds are loans that are repaid at maturity
• Most bonds mature in 10 years
• Face value is the amount the bondholder will
be repaid at maturity
– AKA par value because that is the value printed on
the certificate
Difference Between Stocks and
Bonds
• The bond purchaser is loaning the company or
government money
• If the bond issuer goes bankrupt, the bond
holder is a creditor and will be repaid during
liquidation
• A stock holder has no claim on the company
assets and can lose their entire investment
Corporate Bonds
• Sold by corporations on the open market, like
stocks
• Fixed income instruments – pay a specified
amount of interest at regular intervals
– Usually twice per year
• Contract rate = interest rate (APR)
• Usually have a face value of at least $1,000
– $5,000 is a common denomination
Corporate Bonds (cont’d)
• Coupon bonds (bearer bonds) require owner
to clip the interest coupon and present it to a
bank for payment.
• Registered bond – interest payments are
mailed semiannually to registered owner
• Callable bond – issuer has the right to pay off
(call back) prior to maturity date
– Corporations can take advantage of drop in
interest rates
– Corporation usually pays a small premium when a
bond is called
Types of Corporate Bonds
• Debenture – backed only by the general credit
standing of the corporation
• Mortgage bond (secured bond) – specific
assets serve as collateral to assure repayment
of the debt
• Convertible bond – can be exchanged for a
specific number of shares of common stock at
a specific price (or higher)
Earnings on Corporate Bonds
• Since APR is fixed and there is no compounding
return on bonds (yield) should equal APR
• Market price of bonds fluctuate, which effects
yield
– If price is higher than purchase price, the bond is
selling at a premium
– If price is lower than purchase price, the bond is
selling at a discount
Yield
Yield = Annual interest dollar amount/Market
Price
• Yield < APR when bond is at a premium
• Yield > APR when bond is at a discount
Price of a 6%
$10,000 bond
Yield Calculation
Yield
Face value
$600/$10,000
6%
Premium (104)
$600/$10,400
5.8%
Discount (96)
$600/$9,600
6.3%
Municipal Bonds
• Munis have a minimum investment of $5,000
• Revenue bond is issued to raise money for a
specific public works project (airports,
hospitals)
– Revenue from the project is used to pay the
interest and repay the principal
• General obligation bond – backed by the
power of the issuer to levy taxes
• Munis carry a lower interest rate than
corporate bonds, but are exempt from federal
and some state taxes
Other Types of Bonds
• Savings bonds and Treasury Bonds
– Low yield, tax free investment
– Considered risk free
• Agency bonds – debt securities issued by
other Federal agencies
– Slightly higher yield than treasury securities
• Zero coupon bonds – sold at a deep discount,
no interest payments, redeemable for face
value at maturity (can be Corporate or
Municipal)
Buying and Selling Bonds
• Full service and discount brokers
• Savings bonds and Treasury securities can be
purchased through the Federal Reserve
System or online through Treasury Direct
– Can purchase at a bank, but will pay a commission
– Payroll deduction option, but it is slow
Evaluating Bonds
• Considered a safe investment
– Fixed payment, debt obligation
• Earn return on bonds by earning interest,
redeeming at face value, and through
appreciation
• Bond prices are impacted by interest rates
– As interest rate rise, the value of bonds decrease
– Bond prices are listed in financial tables of
newspapers and online
Bond Ratings
• Rating agencies include Moody’s and Standard
& Poor’s
– Ratings reflect the relative risk level of the bond
– Highest rating is AAA or Triple A
– Lowest rating is D, which indicates default
• Investment-grade bonds have a minimun
rating of Baa in Moody’s or BBB in S&P
• Junk bonds are highly risky
– Ba/BB or lower