Bài giảng Personal Financial - Chapter 11B Investing Basics and Evaluating Bonds #2

11B Investing Basics and Evaluating Bonds #2Recall the concept of asset allocation11-*One Effect of Asset Allocation: A Weighted Total ReturnUltraconservative “Investors” Are Really Just “Savers”People who invest very conservativelyThey do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings Remember “The Rule of 72”?72/4% = 18 years72/8% = 9 years (money doubles much faster)Identify the Types of Investments You Want to Make Do You Want to Lend Your Money or Own an Asset? Debts – “loanership” (lending) investments.Fixed Maturity – the borrower agrees to repay the principal to the investor on a specific date.Fixed Income – the borrower agrees to pay the investor a specific rate of return for use of the principal.Equities – “ownership” investments.Potential for a higher return by sharing in profitsThe Risk Pyramid Reveals the Trade-offs Between Investment Risk and ReturnInflationTo beat inflation, one must invest money so that it earns a higher after-tax return than the inflation rateReal Rate of Return – the return after subtracting the effects of both inflation and income taxes.Example:10% return, 7.5% after taxes (25% tax bracket), 4% inflation, real rate of return of 3.5% after taxes and inflationObjective 5Recognize Why Investors Purchase Corporate BondsCorporate BondsA corporation’s written pledge to repay a specified amount of money with interestAn interest-only loanConsidered safer than co. stocksA “fixed-income” securityA form of debt financing (bond owners repaid in future)11-*Corporate BondsFace Value Dollar amount bondholder receives at bond’s maturity dateUsually $1,000Coupon rate Stated interest rateInterest payments made every six months Example: $1,000 x 5.8% = $58 (in two $29 payments)Maturity Date = date on which face value repaid; generally 1 to 30 years11-*Corporate BondsBond Indenture Legal document describing conditions of the bond issueTrustee Financially independent firm that acts as the bondholder’s representativeUsually a commercial bank or other financial institution11-*Why Corporations Sell BondsTo raise funds for major purchasesTo fund ongoing business activitiesWhen difficult or impossible to sell stockTo improve financial leverageInterest paid to bondholders is tax- deductible for the firm11-*Types of Corporate BondsDebenture Unsecured debtInvestors become “creditors” if company failsBacked only by the reputation of the issuing company; most corporate bonds are this typeMortgage BondSecured by various assets of the issuing firm, such as real estate and propertyLower interest (coupon) rate since debt is secured11-*Types of Corporate BondsConvertible BondCan be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stockGenerally, coupon rate on a convertible bond is 1% to 2% lower than the rate paid on traditional bondsWould only want to convert when stock price gets higher than the bond’s equivalent value in stock11-*Provisions For Repayment Call Feature of Bonds Corporation can “call in” or buy back outstanding bonds before the maturity dateMost corporate bonds are callableCall-protected for first 5 to 10 years after issueA firm calls a bond issue if the coupon rate they are paying is much higher than the market rateLike consumers refinancing to lower-rate mortgage 11-*What is the effect of called back bonds on investors?Provisions For RepaymentSinking FundCorporations deposit money annuallyTrustee uses the money to retire the bond issue prior to maturitySerial BondsBonds of a single issue that mature on different datesExample: After first 10 years, over the next 10 years, 10% of bonds mature each yearBond11-* Why Investors Purchase Corporate BondsInterest Income - “Fixed Income”Registered Bond- tracked electronicallyCoupon and principal paid to registered owner (check or direct deposit)Registered Coupon BondRegistered for principal onlyCoupon must be presented to obtain paymentZero-Coupon BondPays no interestSold at a discount from face valueRedeemed at face value at maturity11-*Bond Why Investors Purchase Corporate BondsDollar Appreciation of Bond ValueBond values change with market interest ratesBond value vs. Interest rates = inverse relationshipIf Market rate Face valueIf Market rate > Coupon rate ← Price < Face valueBond values change with the financial condition of the issuing company or government unitBond Repayment at MaturityFace value repaid on maturity date (will be worth less due to inflation)Bondholders may keep till maturity or sellPortfolio diversification beyond stock and cash assets11-*Approximate Bond Value Formula5.875% interest on ($1,000 bond) = $58.75New issues paying 5% (decrease in coupon rate)Dollar amount of interest $58.75 Comparable interest rate = 5% (.05) = $1,175Bond worth more than face value because it pays interest rate higher than current market rateNew issues paying 6.5% (increase in coupon rate)Dollar amount of interest $58.75 Comparable interest rate = 6.5% (.065) = $903.85Bond worth less than face value because it pays interest rate lower than current market rate Premiums and Discounts When a bond is first issued, it is sold in one of three ways:at its face valueat a discount below its face value orat a premium above its face value.Price Changes for BondsWhat does this graph tell you?Objective 6Evaluate Bonds When Making an InvestmentSources of Information – The InternetThe issuing firm’s websitewww.bondsonline.com coverage of bond transactionsWall Street Journal, Barrons, Internet Other Sources of InformationBusiness PeriodicalsFederal Agencieswww.federalreserve.govwww.treasury.govwww.sec.gov11-*Corporate Bond QuotesThe first bond in the list:Matures in 2036Current price = 93.51% of par (discount) = $935.10Pays an annual coupon rate of 5.875% = $58.75 Yield-to-Maturity = 6.365% (considers bond maturity date)Current yield = 6.283% = 5.875/93.51 (interest/price)11-*Bond Ratings Measure Default Risk11-*Decisions Bond Investors Must MakeDecide on risk level.Investment grade bonds: top 4 grades (BBB, A, AA, AAA)Junk bonds (a.k.a., high yield bonds): lower rated and higher riskDecide on maturity.Match to financial goalsDetermine the after-tax return.Taxable versus tax-exemptWrap UpChapter QuizConcept Check 11-5- Calculate Semi-annual Interest and Reasons That Investors Buy BondsConcept Check 11-6- Current Value of Bonds; Explain Bond Ratings