Chapter 10 BONDS MUTUAL FUNDS Chapter 10 Bonds
Chapter 10 BONDS & MUTUAL FUNDS
Chapter 10 – Bonds & Mutual Funds Section 1 – Corporate & Government Bonds Corporate Bonds A Corporate Bond is a loan of money to a corporation, which will be repaid, with interest. Bonds will show the maturity date, which is when it will be repaid The face value of a bond is the amount that will be repaid upon maturity Usually in $1000 increments Most bonds are for 30 years, however, they can be shorter
Chapter 10 – Bonds & Mutual Funds Types of Corporate Bonds Debentures Majority of issued bonds Backed by only the reputation of the company, not the assets If the company fails, you will not be repaid Investors believe the company is on stable financial ground Mortgage bond Also known as a secured bond Bond is backed by the assets of the company (similar to a home mortgage) If the company fails, the mortgage bonds may receive some money when assets are sold
Chapter 10 – Bonds & Mutual Funds Subordinated Debentures Subordinate = “beneath” Gives interest only after all other bondholders are paid Riskier = slightly higher rate of return Convertible Bond Can be converted to common stock MUCH, MUCH lower interest rate Most are never converted
Chapter 10 – Bonds & Mutual Funds How do corporations repay bonds? They could simply pay them off as they mature. One method is to use a “sinking fund” A sinking fund is a fund used to pay back bonds, which is added to annually by the company For example. If a company issues $60 million in 30 -year bonds They would add $2 million a year to a fund (perhaps a little less, with interest) so that in 30 years, there will be $60 million in that fund. Second method is issuing Serial Bonds are issued in sequence with different maturity dates Thus, the bonds don’t all become due at the same time
Chapter 10 – Bonds & Mutual Funds Most bonds are also “callable” This is where the company “calls in” the bonds, and will pay them off early When companies call in a bond they usually have to pay a premium Most bonds cannot be called in their first 5 -10 years (for a 30 year bond) The premium is extra money paid above the face value Ex. A $1000 bond might be called in at a cost of $1200. If they were paying 6% interest, only 3+ years of interest is about the $200 extra
Chapter 10 – Bonds & Mutual Funds
Chapter 10 – Bonds & Mutual Funds Why do companies sell bonds? One reason is to raise money when it’s difficult to sell stock The interest that the company pays is tax-deductible (since the bondholder will pay it) Why do investors buy bonds? Bonds are more stable than stocks Stocks, however, generally provide greater historical returns
Chapter 10 – Bonds & Mutual Funds There are several different types of bonds Registered Bonds Only the registered bondholder can collect interest/face value This is what most bonds are today Coupon Bond Anybody can collect the interest (using coupons attached to the bond) Only registered bondholder can collect the face value Bearer Bond If you possess the bond, you can collect both the interest/face value Zero-coupon Bond A bond that will no longer pay interest (generally very low in cost)
Chapter 10 – Bonds & Mutual Funds How do investors make money off of bonds Interest payments Usually paid every 6 months to the bondholder (or registered bondholder) Market Value The price of bonds fluctuates with the market If interest rates rise, bond prices go down (There is an inverse relationship) Can also change value based on likelihood of repayment Repayment at maturity If you buy a bond at below face value, you can make money upon repayment of that bond.
Chapter 10 – Bonds & Mutual Funds Government Bonds & Securities Treasury Bills, Notes, & Bonds Treasury Bills (T-bill) Sold in units of $1000 Mature in 4 -weeks, 13 -weeks, 26 -weeks, or 52 -weeks (1 year maximum) They are called Discounted Securities. You pay less than face value. For example: Pay $950 dollars for a 52 -week T-bill, receive $1000 at maturity Very low rate of return Also, very, very safe.
Chapter 10 – Bonds & Mutual Funds Treasury Notes (T-notes) $1000 units as well Have longer maturities (between 1 -10 years) Slightly higher rate of return as well Treasury Bonds (T-bonds) No longer issued (discontinued in 2001, so there are still some out there) $1000 units, 30 year maturity
Chapter 10 – Bonds & Mutual Funds U. S. Savings bonds Series EE – discounted securities “Mature” at variable times to reach full value Depends on current interest rates Will continue to earn interest up to 30 years Series I – full value TIPS – Treasury Inflation Protected Securities Interest rate is variable based on CPI (Consumer Price Index… AKA inflation)
Chapter 10 – Bonds & Mutual Funds Agency Bonds issued by specific agencies within the government Fannie Mae Sallie Mae State & Local Government Bonds Municipal Bonds Used to pay for major projects in communities (schools, airports, stadiums) Tax-exempt income Higher risk than federal bonds, but still very safe
Chapter 10 – Bonds & Mutual Funds Section 2 – Investing in Bonds Bond Price Usually reported at a percentage “ 84” means 84% of face value for that series of bonds Bond Ratings Bonds are rated by 2 companies Standard & Poors (S & P) Moody’s Their ratings are slightly different, but the concept is the same
Chapter 10 – Bonds & Mutual Funds Bond Ratings High Quality – AAA, AA Medium Grade – A, BBB Speculative – BB, B Default – CCC, C, D Ratings are listed “highest” first (AAA is better than AA) There also “subratings” (AA+, AA-), just like grades in school Anything BBB or better is considered investment grade, and is a safe investment
Chapter 10 – Bonds & Mutual Funds Bond Yield There are 2 yields on a bond. One is the interest rate (5. 5% on a $1000 bond, pays $55 a year in interest) The bond yield takes into account the market value of the bond. So a 5. 5%, $1000 bond, whose face value is only $800 because bond rates will have a bond yield of $55/$800 = 6. 875% As the bond values change, the bond yield can as well It does tend to remain fairly steady however.
Chapter 10 – Bonds & Mutual Funds Section 3 – Mutual Funds A mutual fund is where investors pool their money together to buy stocks, bond, and other investments Investors who have limited funds can gain access to otherwise inaccessible investments! Why do investors buy mutual funds? 1. Diversification!!!! 2. Professional Management (for a low cost!) 3. Very popular, so it’s not going away
Chapter 10 – Bonds & Mutual Funds Types of Mutual Funds Closed-End Mutual Funds that have a fixed number of shares To buy into a closed-end mutual fund, you must buy shares from somebody selling They are like individual stocks in this way Rare. Less than 5% of mutual funds are closed end
Chapter 10 – Bonds & Mutual Funds Open-end “Unlimited” number of shares You will purchase shares at the NAV (Net Asset Value) Similar to the market value for stocks/bonds If you invest in the fund, the fund will purchase more stocks/bonds in their current allocation Fees in mutual funds Load Funds Pay a commission every time you buy or sell shares of the mutual fund Will also receive professional advice on when to buy/sell Generally for large investors in funds
Chapter 10 – Bonds & Mutual Funds No-load funds No commission fees for buying or selling No salespeople Management Fees Fixed Fee - % of total assets in the fund Back End Load – Fee to withdraw early 12 b-1 Fees – Marketing & Advertising Fees Total Expense Ratio – All the fees added together, expressed as a percentage The lower this number the better! We saw earlier what a 2% reduction can do!
Chapter 10 – Bonds & Mutual Funds Categories of Mutual Funds are categorized by what they invest in Mutual Funds can be in multiple categories as well Examples can include Aggressive Growth Stock Mutual Fund Income Stock Mutual Fund Seeks auick growth Dividend paying stocks Municipal Bond Mutual Fund Invests in municipal bonds
Chapter 10 – Bonds & Mutual Funds A few mutual funds to talk about specifically Index Mutual Funds (either stock or bond) Mutual funds that are tied to a specific index Passively managed, meaning there is just a computer formula determining what is invested in Has very, low fees Have historically done just as well as actively managed funds. Even better when you factor in the lower fees!
Chapter 10 – Bonds & Mutual Funds Section 4 – Investing in Mutual Funds Where do you find information on mutual funds and their performance? The prospectus! How do you make money on Mutual Funds? Income dividends Capital Gains Investments in the mutual fund pay dividends, those can be passed on to you Investments in the mutual fund go up in value, the profits can be passed on to you Selling shares The value of the mutual fund goes up, you sell, make money
Chapter 10 – Bonds & Mutual Funds Taxes on Mutual Funds Income dividends are reported as income, and taxes are paid accordingly Capital gains, within the fund, are reported as capital gains, and taxes are paid as capital gains Capital gains taxes are generally lower than income taxes When you sell shares, what you pay will depend on how long you held the shares If less than 1 year – they are taxed as income If more than 1 year – they are taxed as capital gains
Chapter 10 – Bonds & Mutual Funds How do you buy mutual funds Regular Account Transactions Meet with a broker, at a brokerage firm to arrange for purchase Usually for larger amounts Voluntary Savings Plans Agree to purchase a set amount per month Can be done through a brokerage firm, or through payroll deductions Reinvestment Plans Reinvest your dividends/capital gains to purchase more shares
Chapter 10 – Bonds & Mutual Funds Withdrawal options Investment period withdrawal Asset Growth Withdrawal Only withdraw the “growth” in the account (or a percentage of it) This means your income could vary from period to period! Dividend & Distribution Withdrawal Take an amount out each period (3 months) Only dividends and capital gains are withdrawn The last 2 options will mean you don’t lose any principal from your withdrawals.
- Slides: 27
