© 2013 pearson education, inc. all rights reserved.14-1 chapter 14 investing in bonds and other...
TRANSCRIPT
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Chapter 14
Investing in Bonds and Other
Alternatives
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Introduction
• Bonds carry less risk than stocks.
• Bonds provide steady income.
• But returns from bonds are not necessarily low.
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Why Consider Bonds?
• Bonds reduce risk through diversification.
• Bonds produce steady income.
• Bonds can be a safe investment if held to maturity.
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Basic Bond Terminologyand Features
• Par value
• Maturity
• Coupon Interest Rate
• Indenture
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Treasury and Agency Bonds
• Risk-free
• Not callable
• Lower interest rate
• Most interest payments are exempt from state and local taxes.
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Treasury and Agency Bonds
• Treasury-issued debt has maturities from 3 months to 10 years.
• Bills, notes, and bonds differ by maturity and denomination.
• Agency bonds
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Treasury and Agency Bonds
• Pass-through certificates issued by the Government National Mortgage Association “Ginnie Mae”
• Treasury Inflation Protected Securities (TIPS)—par value changes with the consumer price index to guarantee investor a real rate of return
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Municipal Bonds
• “Munis”—issued by states, counties, cities, public agencies e.g. school districts
• General obligation bond
• Revenue Bonds
• Serial maturities
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Special Situation Bonds
• Zero Coupon Bonds—don’t pay interest and are sold at a deep discount from their par value
• Junk Bonds—also high-yield bonds, very risk, low-rated BB or below
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Bond Ratings – A Measureof Riskiness
• Moody’s and Standard & Poor’s provide ratings on corporate and municipal bonds.
• Ratings involve a judgment about a bond’s future risk potential.
• The poorer the rating, the higher the rate of return demanded by investors.
• Safest bonds receive AAA, D is extremely risky.
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Table 14.1 Interpreting Bond Ratings
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Bond Yield
• Current Yield—ratio of annual interest payment to the bond’s market price
• Yield to maturity—true yield or return that the bondholder receives if a bond is held to maturity—measure of expected return
• Equivalent taxable yield on municipal bonds
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Bond Valuation
• The value of a bond is the present value of the interest payments plus the present value of the repayment of the bond’s par value at maturity.
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Bond Valuation
• If the issuer becomes riskier, the required rate of return should rise.
• A change in general interest rates, the required rate of return should increase.
• When interest rates rise, the value of outstanding bonds falls.
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Why Bonds Fluctuate in Value
• Inverse relationship between interest rates and bond values in the secondary market.
• When interest rates rise, bond values drop, and when interest rates drop, bond values rise.
• Longer-term bonds fluctuate in price more than shorter-term bonds.
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Why Bonds Fluctuate in Value
• As a bond approaches maturity, the market value approaches its par value.
• When interest rates go down, bond prices go up, but upward price movement on bonds with a call provision is limited by the call price.
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Figure 14.3 The Price Path of a 12 Percent Coupon Bond over Its Life
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What Bond Valuation Relationships Mean to the Investor
• If you expect interest rates to go up (bond prices to fall)—purchase very short-term bonds.
• If you expect interest rates to go down (bond prices to rise)—purchase bonds with long maturities and are not callable.
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Figure 14.4 How to Read Online Corporate Bond Listings
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Preferred Stock—An Alternative to Bonds
• A hybrid security with features of common stock and bonds.
• Similar to common stock—no fixed maturity date, not paying dividends won’t bring bankruptcy.
• Similar to bonds—dividends are fixed, paid before common and no voting rights.
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Investing in Real Estate
• Requires time, energy, and sophistication
• Direct investments in real estate
• Indirect investments in real estate
• Investing in real estate: the bottom line
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Investing – Speculating in Gold, Silver, Gems, and Collectibles
• Don’t do it!
• This is not investing—it is speculation.
• Collectibles may only have entertainment value.
• Don’t expect them to provide for your financial future.