Bonds: An Intro
• A bond is essentially an IOU; a promissory note of a debt to be paid. • Sometimes also called “senior securities” or “fixed-income” securities. • Usually, bonds are long-term (10-30 years) but sometimes shorter terms. •
Bonds: An Intro (con’t)
• Bonds are usually considered “safer” than stocks because of lower volatility in prices • Bonds generally have a lower overall return on your investment than stocks
Who Issues Bonds?
• Almost everyone (except individuals): • companies, governments, banks, hospitals, utilities, cities, counties, state government, etc. • And, especially, Uncle Sam
Why Invest in Bonds? What does the Investor Get Back?
• 1. Repayment of your principal (what you loaned them originally) when the bond matures • 2. Pay you a specified interest rate at specified times until maturity or redemption of the bond
Who Issues Bonds (con’t)
• They are issued about the same way as stocks but usually by underwriters and investment banks that specialize in bonds. • The federal government issues its own bonds.
Corporate Bonds
• 1. First mortgage bond: secured by the property of the company • 2. Collateral trust bond: secured by other stocks and bonds held by the company
Corporate Bonds (con’t)
• 3. Equipment bonds: secured by title to company’s moveable equip. • 4. Debentures: secured only by the general credit of the company. Some debentures are convertible to stock, etc.
Corporate Bonds (con’t)
• Corporate bonds have a secondary market, meaning that if a bond buyer does not hold it to maturity it is sold in the secondary market and can be purchased by an investor. • Listed in newspapers, WSJ, etc., S&P’s Bond Guide and Mergent’s Bond Record is the major listing of all types of corporate bonds.
Corporate bonds (con’t)
• Face Value: the value of the bond at the time of maturity; what you pay for it when you buy one (unless offered at a discount). • Face value will not change but the market value of the bond may change depending on interest rates. • Corporate bonds are usually issued in denominations of $1,000 each. Check daily prices (of those traded) in WSJ; others in Bond Guide.
Federal Government Bonds Not Marketable Types
• 1. Series E/EE bonds: $25 minimum and purchased at a discount; fixed interest rate • 2. Series H/HH bonds: minimum $500 and purchased at face value; interest paid every 6 months; fixed interest rate; restrictions apply. • 3. I-bonds: Min=$50; max=$10,000; purchased at face value and accrue interest; redeemable after 6 mos.; interest is two types: fixed and variable semi-annual rate; buy at your bank; registered.
Federal Government Bonds: Marketable
• Treasury bills: short term (1 year or less) and sold at a discount and do not pay interest before maturity. Exempt from state and local income taxes. • Treasury notes: 1-10 year maturity and sold at auction and pay interest before maturity. Investors bid for them at stated auction dates. Registered. Exempt from state and local income taxes.
Federal Government Bonds: Marketable
• Treasury bonds: long-term obligations (greater than 10 years) and sold at auction and pay interest until maturity. Registered. Exempt from state and local income tax. • All Treasury bills, notes, and bonds are actively marketed on the open market and prices listed in WSJ, etc. May also be purchased directly from Treasury Direct.
Treasury Inflation Indexed Securities (TIPS)
• US Treasury notes and bonds with inflation protection. Sold at regular auctions and thru TreasuryDirect. Interest rate is a combination of the fixed rate and the inflation adjusted rate. (Impossible to lose money!) Amounts purchasable varies. • Detailed info at: • http://www.treasurydirect.gov/sec/seciis.htm
US Government Bonds: Advantages and Disadvantages
• Advantages:
– – – – 1. Safe (better than AAA) 2. Easy to get, sell, cash in, etc. 3. Lots of investment choices 4. Income not taxable by state & local gov
• Disadvantages:
– 1. Usually lower and locked in interest rate – 2. Usually does not outperform stock market
Other US Government Securities
• 1. Strips (zero coupon Treasuries): the interest rate payments are stripped from the principal repayment (sold only by brokers, etc.) See Treasury direct Web page for explanation. • 2. Wholly-owned US federal corporations (Fannie Mae, Freddie Mac, etc.): all issue bonds, available on the open market (see WSJ pages for interest, price, etc. and Web page at each company for details. •
Municipal/State Bonds
• Issued by state and local government agencies. Usually tax free (most federal and usually residents of issuing state). • Marketable: listed in newspaper, etc. • Major advantage is tax free status. • Usually lower interest rates offered. • Watch for rating by S&P, Moody’s, et. Al. • Major listing is Mergent Municipal…
Bond Ratings
• THE major factors in buying a (non US government) bond are: • 1. Interest rate • 2. Bond rating: Usually done by S&P or Moody’s (Mergent Bond Record) • Rating systems vary from service to service but usually: AAA, AA, A, BAA, BA, B, CAA, CA, C
Bond Ratings (con’t)
• Any rating below B is considered speculative (junk bonds) and any CAA rating means possible default; CA = default and C=default with unlikely recovery. • Moody’s ratings are better for municipal bonds and S&P better for corporate bonds.
Callable Bonds
• Callable bonds are those designated by the issuer as being subject to payment of the principal earlier than the date of maturity. Otherwise, everything else is the same in terms of interest rate, marketability, etc.
How to read bond prices in the daily paper
• Not all bonds are listed in the daily paper (not even in the WSJ). There are more than 1.5 million bonds in the municipal market alone. • Only a few of the outstanding bonds (those available for trading) trade on any given day. Bond prices are primarily affected by changes in interest rates.
How to read bond prices in the daily paper:2
• Bond information in the daily paper for corporate and government bonds usually contain about the same information: Examples: • Rate Maturity Bid Ask Change Ask/Yld 7 ¾ Feb. 08 105:12 105:14 5.50
5 3/8 Feb. 08 99:26 99:27 5.44
How to read bond prices in the daily paper:3
• • • • For the first example: Interest rate paid= 7.75 interest to holders Maturity date = February, 2008 Bid price = 105:12 ; this means that a buyer was willing to pay for a $1,000.00 face value bond, $1,053.75, while the seller was asking $1,054.38, a real money difference of 63 cents for each $1,000 bond bought.
How to read bond prices in the daily paper:4
• Each number after the colons in the price represents 32nds. (Bonds are quoted in 1/32 of a fraction of a dollar.) To convert these fractions to $ simply divide (in the first example) as: 12/32=.375 and move the decimal to get $3.75; then, add that to the base price of the bond, $1,050, to get the total bid price of $1,053.75 • Thus, if the bond holder sold this bond at the asking price he/she would make a profit of more than 5%, indicated by the ask/yield price. • For the second bond, with a much lower interest rate, the bond is selling below its face value of $1,000 ($998.44), realizing a 5.44% yield rate.
How to read bond prices in the daily paper:5
• Corporate bond listings for traded bonds appears slightly differently in the paper: • Examples: • Name Curr.Yld. Vol. Close NetChg. • BosCelts 6s38 9.2 22 65 3/8 +1/4 • PacBell 7 5/8 34 6.7 5 99 1/8 -1/8
How to read bond prices in the daily paper:6
• For the first example: • Name: Bond for the Boston Celtics
– 6 = interest rate of 6% annually; s simply separates the interest rate from the year, 2038, the bond matures
• Curr. Yield: 9.2=actual interest rate given the closing price of 65 3/8 (which translates to $653.75 per $1,000 bond) • Vol= 22 bonds at $1,000 each • Net Chg=1/4 which is $2.50 above yesterday
How to read bond prices in the daily paper:7
• For more on how to read bond prices see: • www.investinginbonds.com/bondprices.htm • Also see Wikipedia under bonds
CDs: Certificates of Deposit Sort of like bonds
• CDs are a way to invest in government securities for a limited period of time with a fixed return. Generally considered safe and a place to put your money while deciding what securities to invest in next. Interest rate is usually less than average of t-bills. Buy at your bank or savings and loan. Short-term (usually 6 months) investment.
Understanding Bonds: Sources
• A very nice site for understanding bonds and how to read the bond listings in the daily paper (or WSJ) is: • http://www.investinginbonds.com/bondprices.htm • And, see also their more detailed Web site: • http://www.investinginbonds.com/ • And, the Bond Professor at: • http://www.bondsonline.com/bpfaq.html
Mutual Funds: An Intro
• What is a mutual fund?
– An investment company that buys stocks, bonds, etc. of other companies and holds them for an investment. You buy shares in the fund and own it “mutually” with other shareholders of the fund. – Mutual funds issue new shares as they receive new investments from shareholders. Unlimited number of outstanding shares, usually.
Mutual Funds: An Intro: 2
• What kinds of mutual funds are there? • From a broad perspective, there are two types: • 1. Load funds: you pay a sales commission to purchase shares of the fund. • 2. No-load funds: no commission is paid to purchase shares. You pay NAV for shares.
Mutual Funds: An Intro: 3
• Types of mutual funds (con’t): • Sales charges (the “load”) vary from fund to fund. Check this out before buying. Most load funds are sold by brokers, etc. • No-load funds are usually purchased directly from the fund itself. • Both type of funds charge a management fee, which varies in % by fund.
Mutual Funds: An Intro: 4
• What kinds of investment opportunities in mutual funds?: almost all kinds! • There are thousands of mutual funds with all kinds of specializations as well as general funds. • Some sample categories: by industry focus; index funds; bond funds; technology funds, tax-free funds; S&P 500 funds; etc.
Mutual Funds: An Intro: 6
• Advantages of mutual funds:
– Spread your risk over several companies – Generally less daily fluctuation in prices – “Expert” management
• Disadvantages of mutual funds:
– You have no say in investments by the fund – Fund may make poor choices of equities – Redemption of shares takes a day or so
Mutual Funds: An Intro: 7
• How do I choose a mutual fund?:
– What are my investment goals? – The track record of the funds that meet your goals – The current record of the fund and the price – Get prospectus (Web page or write the fund) and annual report of the fund before investing. – Note: some mutual funds have an minimum initial investment
Mutual Funds: An Intro: 8
• What are best sources on mutual funds?: • Web Sources:
– Morningstar.com – Individual mutual fund Web pages – Yahoo, et. al. using the mutual fund ticker symbol to get quotes and research – WSJ.com
Mutual Funds: An Intro: 9
• What are the best sources on mutual funds?: • Print Resources:
– – – – – Morningstar Weissenberger Forbes Magazine (selected issues) Money Magazine (selected issues) WSJ (various issues with irregular special reports)
Mutual Funds: A Reprise
• 1. Don’t forget bond mutual funds
– All types of these (Treasuries, corporate, tax-free, etc.) and they are a nice alternative comparison to buying individual bonds
• 2. Don’t forget index mutual funds
– There are all types (DJI, S&P 500, Russell2000, etc.) and they are a nice comparison with individual mutual funds
• 3. Use www.morningstar.com for some interesting features to compare funds (and stocks), calculate return, etc.; requires registration
Money Market Funds: 1
• What is a money market fund?
– A fund (or company) that invests in short-term debt securities (bonds, Treasury notes/bills, cds, etc.) using the money invested by investors.
• How do they operate?
– Much like a mutual fund but they hold very short-term investments. They are mostly used as a short-term holding “place” for investor funds between long-term investments.
Money Market Funds: 2
• Who has money market funds?
– Just about everyone these days: banks, brokerage firms, mutual funds, etc.
• How does the investor use them?
– Your broker or banker makes them available to you and you use them as a short-term holding place until you decide on longer-term investments. Usually pay very low interest rate.
Other Investment Alternatives:1
• Savings and Loans:
– Safe (if FDIC insured) but dull! Usually pay low interest rate. – Offer a wide variety of investment opportunities for investors: IRAs, Keogh plans, CDs, money market, etc. – Key consideration is FDIC insured.
Other Investment Alternatives: 2
• IRA (Individual Retirement Account): • Two Basic types:
– Traditional IRA: tax deductible (with income limitations), with annual amount limited. – Roth IRA: not tax deductible but no taxes on capital gains after 5 years; everyone eligible to participate; annual amount limited. Take funds out without penalty at 59.5 age. Education, new home, etc. choices.
• Invest via: S&Ls, banks, credit union, selfmanaged account (with broker, mutual fund, etc.)
Other Investment Alternatives: 3
• Commodities: very risky for the average investor! Sometimes called “futures” • In essence, you are buying a specific commodity (wheat, pork bellies, coffee, etc.) to be delivered at a specified time in the future at a specified price. Unless you plan on taking possession of the commodity, you are speculating on the possibility that the price of the commodity will rise by the time you have to take delivery. • Information about commodities are not usually library type questions. Keep up via WSJ, with daily price quotes.
Other Investment Alternatives: 4
• Collectibles: Know what you are doing— and love the things you are collecting!
– Generally, collectibles are considered risky investments. Roughly, as an investment they fall into two categories: – (1) for the collector who wants the collectible because he/she “loves” them. – (2) for the investor who is collecting strictly for investment purposes.
Other Investment Alternatives: 5
• Collectibles (con’t) • Ordinarily, the collector is not trend oriented but the collectible investor is very much oriented towards trends. • In some areas (old masters, rare coins, etc.) investors have done very well but in others (particularly if late into a trend) they have done poorly. Caveat emptor!
Other Investment Alternatives: 6
• • • • • • • Collectibles (con’t) Rules for collectible investing: 1. Be knowledgeable about the area 2. Decide on your objectives 3. Specialized in an area you like 4. Be able to wait out adverse trends 5. Keep informed (read manuals, magazines, Web pages, listservs, etc.) on a regular basis.