Hace 3200 1nd EditionExam # 4 Study Guide Lectures: 25-32Lecture 25- Chapter 14: Investing in bonds and other investmentso What are bonds? Similar to an I.O.U. When you purchase a bond, you are lending money to a government. Municipality, corporation, federal agency or other entity known as the issuer. The issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond( the principal) when it “matures” or comes due- Why consider bonds?o Bonds reduce risk through diversificationo Bonds produce steady current income.o Bonds can be a safe investment if held to maturity.- Basic Bond Terminology and Featureso Par Value( face value)- the amount returned to the holder at maturityo Coupon interest- indicates the percentage of the face value that will be paid annually to the holder in the form of interesto Indenture- a document that outlines the terms of the loan agreement.- Basic Bond Terminology and Featureso Call Provision- allows the issues to repurchase the bonds before the maturity dateo Sinking Fund- money set aisde annually ti pay off the bonds at maturity - Bond Investment Considerationso Interest rate: Fixed, floating, or payable at maturity o Redemption features Call provisions( when % rates drop) Puts- you make issuer buy back bond( when % rates increase)o Tax Status Interest may or may not be taxable- Different Types of Bondso Corporate bondso Treasury and agency bondso Municipal bonds- Corporate Bondso Corporations borrow $$ by issuing bondso Secured corporate debts are secured bu collateral or real property lienso Unsecured corporate debts are not secured by collateral, and pay higher return- Treasury and Agency Bondso Treasury(T) bonds( US treasury) Bills, notes, and bonds Treasury inflation-indexed bondso Savings bonds( US treasury) U.S. Series EE bonds I bondso Agency bonds Pass-through certificates (mortgages)- Treasury Bills, Bondso Bills mature in 3,6, or 12 monthso Bonds mature in 10 to 30 yearso All are sold in denominations of $1000- Agency Bondso Issued by the government agencies; authorized by congresso Low risk, with interest rates slightly higher than treasury issueso Minimum denomination of $25,000 with maturities from 1 to 40 years- Agency Bondso As a savvy investor, you should be familiar with three key members of the government agency bond family- Ginnie Mae, issued by the Government National Mortgage Association(GNMA); Fannie Mae, issued by the Federal National Mortgage Association(FNMA); and Freddie Mac, issued by the federal Home Loan Mortgage Corporation( FHLMC)- Fannie Mae & Freddie Maco The Federal National Mortgage Association stockholder-owned corporation chartered by Congress in 1968 as a government sponsored enterprise, but founded in 1938 during the Great Depression. The Corporation’s purpose is to purchase and securitize mortgages in order to ensure that funds are consistently available to the institutions that lend money to home buyerso The Federal Home Loan Mortgage Corporation, known as Freddie Mac was created in 1970 to expand the secondary market for mortgages in the US. This secondary mortgage market increases the supply of money available for mortgage lending and increases the money available for new home purchases.o The two GSEs have outstanding more than US$ 5 trillion in mortgage backed securities( MBS) and debt; the debt portion alone is $1.6 trillion- Fannie Mae & Freddie Maco On September 7, 2008, the Federal Housing Finance Agency( FHFA) announced that Fannie Mae and Freddie Mac were being placed into conservatorship of the FHFA. The action is “one of the most sweeping government interventions inprivate financial markets in decades”. As of 2008, Fannie Mae and the Federal Home Loan Mortgage Corporation( Freddie Mac) owned or guaranteed about half of the U.S. $12 trillion mortgage marketo In 2003, the Bush Administration sought to create an agency to oversee Fannie Mae and Freddie Mac. While Senate and House Leaders voiced their intention to bring about the needed legislation, no reform bills materialized.o Poor loans were made, economy is paying the price!- Pass-Through Certificateso Issued by the government National Mortgage Association( Ginnie Mae)o Minimum $25,000 certificate for pool of mortgageso Principal and interest repaid monthly- Pass-Through Certificateso Mortgage-backed cetrtificates are the most common type of pass-through, where homeowner’s payments pass from the original bank through a government agency or investment bank to investors.- Treasury Inflation- indexed Bondso Maturities of 10 years and a minmum par value of $1,000o Inflation increases the face value of the bond, guaranteeing the investor of a real returno Tax compilation- must pay taxes annually on par value adjustments( interest)- U.S Series EE Bondso Purchases price is one-half of the face value, ranging from $50 to $10,000o Rate of return varies with the market rateo Have a guaranteed minimum interest rate based on treasury securitieso High level of liquidity, but cashing in before maturity may reduce yield - Municipal Bonds( Muni’s)o Issued by to find public projectso Interest earnings are federal tax-exempto Can be exempt from state taxes if you live in the state where the bonds issuedo Not very liquid, due to lack of a secondary market- Zero- Coupon Bondso Issued by corporations, municipalities, and the treasury( e.g STRIPS)o Do not pay interest each yearo Are sold at a discount from face valueo The price at maturity includes interest payments in lump sum- How to invest in bondso Most sold on the OTC Usually sold in $5,000 denominationso Bond funds Diversify across a broad range of bondso Bond Unity Investment Trusts Government, municipal and mortgage bonds- Bond Yieldo Is the total return on a bond investmento Is not the same as the interest rateo Is affected by the bond price which may be more or less than face value- Current Yieldo Ratio of annual interest payments to the bond’s market priceo Current yield Annual interest payments/ market price of the bondo Consider a bond with an 8% coupon interest rate, a par value of $1,000 and a market price of $700, the current yield would be..- An exampleo Current yield 0.08*$1,000(annual interest payments/ $700( market price of bond) current yield= 80/700- 11.4 percent- Yield to Maturityo True yield received if the bond is held