Investing in Financial Investing in Financial AssetsAssets

Your homework over Your homework over the weekend was to the weekend was to ask three people of ask three people of different ages and different ages and genders if they save genders if they save and the reasons they and the reasons they do. What were some do. What were some of the results? of the results?

An IOU that you draft An IOU that you draft and give to a friend in and give to a friend in payment of a debt is payment of a debt is an example of a an example of a financial asset. Why financial asset. Why is this so? is this so?

Savings vs. InvestmentsSavings vs. Investments

Savings:Savings: SafeSafe Easy Easy Low ReturnLow Return Used for Short-term Used for Short-term

goalsgoals

Investments:Investments: Involves RiskInvolves Risk Volatile in short time Volatile in short time

periodsperiods Offers potential growthOffers potential growth Used for mid-term and Used for mid-term and

long term goalslong term goals

Pretest and Advertising ActivityPretest and Advertising Activity

http://www.orangekids.com/amy/invest_ip_http://www.orangekids.com/amy/invest_ip_002.htm002.htm

Risk LagoonRisk Lagoon

Why do you think the fishing spot on Planet Why do you think the fishing spot on Planet Orange was called Risk Lagoon?Orange was called Risk Lagoon? How would you describe the potential return on How would you describe the potential return on Risk Lagoon- high or low? Risk Lagoon- high or low? Who had a positive return on their investment at Who had a positive return on their investment at Planet Orange?Planet Orange? Who do you think is better off time and money-Who do you think is better off time and money-wise, Donia or Bubba?wise, Donia or Bubba? Ted not only failed to catch a fish, he lost the Ted not only failed to catch a fish, he lost the money he had invested! How much did Ted money he had invested! How much did Ted lose? lose?

BONDS!BONDS!

Bonds are long-term obligations that pay a Bonds are long-term obligations that pay a stated rate of interest for a specified stated rate of interest for a specified number of yearsnumber of years

It is the money that the issuer is BOUND, It is the money that the issuer is BOUND, or OBLIGATED to repator OBLIGATED to repat

Bonds as Financial AssetsBonds as Financial Assets

1) 3 Bond 1) 3 Bond components:components: Coupon- stated Coupon- stated

interest on the debtinterest on the debt Maturity- life of the Maturity- life of the

bondbond Par value- aka Par value- aka

“principal”, or the “principal”, or the amount repaid to the amount repaid to the lender at maturity. lender at maturity. Dollar valueDollar value

A corporation sells a A corporation sells a 6 percent, 20-year, 6 percent, 20-year, $1,000 par value $1,000 par value bond that pays bond that pays interest semi-interest semi-annually.annually.

How much does the How much does the holder receive semi-holder receive semi-annually?annually? Hint: .06(1000)/2Hint: .06(1000)/2

Bonds as Financial AssetsBonds as Financial Assets

2) Bond Prices2) Bond Prices Investors consider Investors consider

changes in future changes in future interest rates, the risk interest rates, the risk the company will the company will default, and other default, and other factorsfactors

Supply and demand Supply and demand determine final pricedetermine final price

Ex. Investors views Ex. Investors views the bond as a the bond as a financial asset that financial asset that will pay $30 twice a will pay $30 twice a year for 20 years, year for 20 years, plus a final par value plus a final par value payment of $1,000payment of $1,000 Investors can offer Investors can offer

$950, $1,000, $1,100 $950, $1,000, $1,100 or any other amount or any other amount for this future payment for this future payment streamstream

Bonds as Financial AssetsBonds as Financial Assets

3) Bond Yields- annual 3) Bond Yields- annual interest divided by interest divided by purchase price (used to purchase price (used to compare bonds)compare bonds)

**Note: because the **Note: because the creditworthiness of creditworthiness of corps. differ, not ALL corps. differ, not ALL bonds (6%, 20-year, bonds (6%, 20-year, $1,000 will cost the $1,000 will cost the same)same)

Bonds are not insuredBonds are not insured

Ex. Investor pays Ex. Investor pays $950 for bond, current $950 for bond, current yield would be $60 yield would be $60 divided by $950, or divided by $950, or 6.32%6.32% If investor paid $1,100 If investor paid $1,100

for bond, the current for bond, the current yield would be $60 yield would be $60 divided by $1,100. or divided by $1,100. or 5.45%5.45%

Bonds as financial assetsBonds as financial assets4) Bond Ratings- 4) Bond Ratings- use letters to use letters to check the quality check the quality of bondsof bonds Standards and Standards and

PoorPoor Moody’sMoody’s

Bonds with high ratings sell at Bonds with high ratings sell at higher prices than do bonds higher prices than do bonds with lower ratingswith lower ratings

6%, 20-year, $1,000 par value 6%, 20-year, $1,000 par value bond with a AAA rating may bond with a AAA rating may sell for $1,100sell for $1,100

6%, 20-year, $1,000 par value 6%, 20-year, $1,000 par value bond with a BBB rating may bond with a BBB rating may sell for $950 (BUT it has a sell for $950 (BUT it has a higher current yield of 6.32)higher current yield of 6.32)

Riskier investments require Riskier investments require higher returns to compensate higher returns to compensate for the riskfor the risk

How do bond ratings affect the price of How do bond ratings affect the price of bonds?bonds?

Would you buy when interest rates are Would you buy when interest rates are high or low? Why?high or low? Why?

More Math PracticeMore Math Practice

A $10,000 corporate bond issued by A $10,000 corporate bond issued by Products IncProducts Inc