Need Money?

Corporations Get money by…

– Issuing Stock (equity financing)

– Selling Bonds (debt financing)

Government Entities Get money by

– Selling Bonds– Since they are non-

profit, they can not issue stock.

What is a Bond?

A bond is a loan (IOU) given to a lender (investor) by a borrower (corporation or government entity) that needs money.

Selling a bond is simply borrowing money from the public. When you buy a bond you are essentially lending money to a corporation or government entity.

____________________________

Corporations/Government Entities You and I

Borrowers Lenders/Investors

What is a Bond?

Bonds promise to pay back the lender the entire amount of the loan on a particular day. They also pay the lender something additional for the use of his money (interest). (Debt Financing)

Stocks promise….NOTHING! With stocks, you share in the success and failure of the company. (Equity Financing)

The ABC’s of Bonds

Read The ABC’s of Bonds and complete the questions.

You are responsible for understanding the information in this handout.

How Bonds Work

Review How Bonds Work Summary…

– Coupon bonds pay out interest at set intervals, with a final payment that includes the original principal at the maturity date.

– Zero-coupon bonds, on the other hand, pay all the interest and principal of the bond at the maturity date.

You are responsible for understanding the information in this handout.

Why Buy a Bond?

Historically, stocks have resulted in greater profits for investors than bonds. Why, then, should you consider investing in bonds?

Read Why Buy a Bond and answer the question.– I am specifically looking for four (4) reasons investors would

buy bonds. Be prepared to reference the text for each reason.

You are responsible for understanding the information in this handout.

Bond Ratings

Read Bond Ratings – bonds are often rated; the ratings are intended to provide information to investors.

You are responsible for understanding the information in this handout.

Most Corporate Bonds are Callable

A call feature allows a corporation to buy back bonds from bondholders before the maturity date.

Corporations may get the money to call a bond by issuing more stock, using profits, or selling new bonds at a lower interest rate.

Typically companies agree not to call their bonds for the first 5 to 10 years.

When they do call their bonds, they may have to pay bondholders a premium, which is an additional amount above the face value of the bond.

Risks for the Investor

1. Repayment Risk

2. Interest Rate Risk

3. Inflation Risk

Risks for the Investor

Repayment Risk Refers to the borrowers ability to pay interest

and repay principle timely. The credit rating of a bond indicates the

degree of repayment risk.

Risks for the Investor

Interest Rate Risk The risk that interest rates rise and you are stuck with

a fixed rate investment paying interest below the current market.

– Bonds lose value when interest rates increase after the bond is issued.

– If you own a bond at 8%, the current market rate is 10%, and you wanted to sell (to put your money in an investment making a higher rate of return)…investors will be willing to pay less than face value for your bond.

– You’d have to sell it at a discount , “put in on sale”. You’d sell it for less than its face value because no one will want to pay full price for a bond paying interest below the current market.

Risks for the Investor

Inflation Risk Inflation is the general rise in prices over time. Since the dollar amount you earn on a bond doesn’t change, the

value of that income can be eroded by inflation.$1000 $1,030 $30 $30 $30 $30 $30

|____|____|____|____|____|____|Buy Maturity DateBond 3 Years

That $60 of annual income buys less at the end of the term than at the beginning. Why? Because items will cost more at maturity than they did 3 years ago.

The same $60 will buy less!

Why Issuers Prefer Bonds

1. Issuing more stock can dilute (lessen) the value of the common stock already outstanding. Earnings

EPS = -------------------------

Shares Outstanding

2. Income tax advantages to issuing bonds– A corporation can reduce its taxable income by the

amount of interest it pays to bondholders.

How to Read a Bond Table

Read the handout about Bond Price Quotations, Yield of a Bond Investment, and Reading a Bond Table.

You are responsible for understanding the information in this handout.