Investing in Bonds
Descriptive Terms for Bond Features
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .
Registered and bearerZero-couponCallableWarrantsConvertibility
Language of Bond Investing
Indenture
Face value, coupon rate, maturity date
Secured and unsecured
Senior and subordinated
Language of Bond Investing
Interest Income
Assume you purchase $1,000 corporate bond issued by AT&T Corporation. The interest rate for this bond is 6.70%. The annual interest is $67 as shown below:
Dollar amount of annual return = Face value x interest rate
= 1,000 x 6.7%
= 1,000 x .067
= $67.00
Corporate bonds
U.S. government securities
Treasury bills, notes, and bonds Federal agency issues
Municipal Bonds
Types of Bonds
Approximate Bond Value
Assume you purchase a Verizon Communications bond that pays 5.5% interest based on a face value of $1,000 until maturity in 2017. Also assume new corporate bond issues of comparable quality are currently paying 7%. The approximate market value of your Verizon bond is $786 calculated as follows:
Dollar amount of annual interest = $1,000 x 5.5% = $55
Approximate market value = Dollar amount of annual interest
Comparable interest rate
= $55
7%
= $786
Current Yield
Current yield = current annual income current market price = $55 $786 = 7%
State and Local Government Securities
Municipal Bonds
General Obligation Bonds
Revenue Bonds
Effective Yield of a Tax-Free Investment Not paying tax effectively increases your rate of
return you get to keep all of your profits, instead of only
a portion
Example: 28% tax bracket, 5% rate of return
= 6.94%
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What is the Yield or Rate of Return on a Financial Investment?
Annualized Percentage Change:
Example: original price=$20/share, current price=$100/share, stock held for 9 years
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Comparison of Taxable vs Tax Exempt Investments
Tax-Exempt
Yield
15% Tax Rate
25% Tax Rate
28% Tax Rate
33% Tax Rate
35% Tax Rate
4% 4.71% 5.33% 5.56% 5.97% 6.15%
5% 5.88% 6.67% 6.94% 7.46% 7.69%
6% 7.06% 8.00% 8.33% 8.96% 9.23%
7% 8.24% 9.33% 9.72% 10.45% 10.77%
What is the Yield or Rate of Return on a Financial Investment?
=19.58%
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Bond Price Calculation
Assume that a bond has a price quote of 84. The actual price for the bond is $840, as calculated below:
Bond price = Face value (usually $1,000) x bond quote = $1,000 x 84 percent = $1,000 x .84 = $840
Bond Ratings
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .
A plus sign (“+”) following a rating indicates that it is likely to be upgraded, while a minus sign (“-“) following a rating indicates that it is likely to be downgraded.
Susceptibility to certain risks
Credit
Callability
Inflation
Interest rate
Considerations Before Investing in Bonds
Premiums and discounts
Current yield
Yield to maturity
Tax-equivalent yields
When to sell
Considerations Before Investing in Bonds
Bond Prices, Bond Yields, and Interest Rates
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .
Yield to Maturity
Effective Yield of a Tax-Free Investment Not paying tax effectively increases your rate of
return you get to keep all of your profits, instead of only
a portion
Example: 28% tax bracket, 5% rate of return
= 6.94%
1001
taxbracket
r
10028.1
05.
Pay higher interest rates than savings
Offer safe return of principle
Have less volatility than stocks
Offer regular income
Require smaller initial investment
Advantages of Investing in Bonds
No hedge against inflation
Can be quite volatile
Compounding is almost impossible
Subject to investors tax rate
Poor marketability
Disadvantages of Investing in Bonds
Bond Characteristics and Risk
., REVIEW BOOK: Personal Finance. Retrieved Oct 1, 2009 from http://www.flatworldknowledge.com/node/50890 .