Notes

unit 7 lesson 4
Broker - An individual or firm that charges a fee or commission for executing buy and sell orders for stocks and bonds submitted by another individual or firm.
•Par Value - The face value of a bond, generally $1,000 for corporate issues, with higher denominations for many government issues.
•Coupon - The dollar amount of interest earned on a bond.

A $1,000 bond paying 7% interest each year has a coupon of $70. The 7% is the coupon rate.
$1,000.00 X .07 = $70.00
If you purchased this bond, you would receive $70.00 every year until the bond matures.
NOTE: Bonds are also traded publicly, and you can choose to sell your bond before its maturity.

Alternative Options

Zero-coupon bond
Zero-coupon bond does not make periodic interest payments. Instead, the bondholder buys the bond at a much lower price than its face value, and the interest is gained at maturity.

Floating-rate bond
Floating-rate bond has an interest rate that adjusts periodically with market changes, and may allow either the bondholder or issuer to change the maturity date.

Callable bond
Callable bond entitles the issuer to pay off the principal before the maturity date.

Putable bond
Putable bond entitles the bondholder to ask for repayment before the maturity date.

Convertible bond
Convertible bond gives the bondholder the right to exchange the bond for shares of the issuer's common stock.

•$10,000 face value
•98 Quoted price
•8% interest
Cost of bond is $10,000 x .98 = $9800
FACE VALUE X QUOTED PRICE=BOND COST
Annual interest is $10,000 x .08 = $800
FACE VALUE X INTEREST RATE = ANNUAL INTEREST
Annual yield is $800 / $9800 = 8.2%
ANNUAL INTEREST / BOND COST = ANNUAL YIELD

Use a Broker

Most new bonds are issued through an investment bank, also known as the "underwriter." The bond issuer pays the sales fee. Most financial advisors suggest buying these new issues when investing in bonds, rather than buying older bonds that are traded by brokers on what is known as the "secondary market." The fees will be significantly higher on the secondary market, and you know from mutual funds that the more you pay in fees, the less you can make overall.

Different Types of Bonds
Bonds are offered by either private corporations or by the state, locale, or federal government.

-Corporate Bonds
Sold by companies to raise money (alternative to selling stock). Interest is paid periodically and subject to federal income taxes. Most are issued in $1,000 denominations with terms of one to 20 years, though terms can vary greatly. These bonds carry a higher risk, and have a higher yield, than federal government bonds.

-Municipal Bonds
Issued by state and local governments and agencies, with denominations of $5,000 or more and terms of one to 40 years. Interest is paid periodically and is exempt from federal income tax. If you live in the state that issues the bond, interest may also be exempt from state and local taxes as well.

-U.S. Treasuries
Issued by the federal government, these are the safest investment you can make because the interest and principal payments are guaranteed by the U.S. government. Interest is exempt from state and local taxes, but not federal. These bonds have some of the lowest yields due to their almost nonexistent risk, but are very popular and easily converted to cash. U.S. Treasuries come in the following forms:

-Savings Bonds
Two main types are Series EE and Series HH.
•Series EE - come in denominations of $50, $75, $100, $200, $500, $1000, $5000, and $10,000. The purchase price is one half of the face value, and they mature in about 10 years at a guaranteed interest rate of 5.59%, but may be higher. Interest can be tax deferred until the bonds are cashed.
•Series HH - sold in denominations of $500, $1,000, $5,000, and $10,000, with a ten-year term, and pay a fixed 6% interest rate. Interest is paid twice a year and is subject to federal taxes.

-Treasury Bills
Treasury Bills - or T-Bills, have the shortest maturities at 13 weeks, 26 weeks, and one year. They have a face value of $10,000 but you buy them at a discount and receive the full $10,000 at maturity. The discount reflects the interest you earn.

-Treasury Notes
Treasury Notes – or T-Notes, mature in two to 10 years, with interest payments twice a year (semiannually), at a fixed rate. Minimum investment is $1,000 or $5,000, depending on maturity.

-Treasury Bonds
Treasury Bonds – or T-Bonds, are sold in denominations of $1,000 and mature after 10 to 30 years. Interest is paid twice a year.

-Zero-Coupon Bonds
Zero-Coupon Bonds - are sold by brokers at substantial discounts. They mature in six months to 30 years for full face value. You must pay taxes each year on interest earned, which is based on the increased value of the bond even though the interest is not paid until maturity.

-Treasury Inflation-Indexed Securities
Treasury Inflation-Indexed Securities – or TIPS, are issued with maturities of 5 to 20 years. You pay the interest rate that rises or falls with the consumer price index (measures inflation). The interest rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal using the consumer price index, thus protecting the holder against inflation. You must pay taxes on the interest received and based on the increased value due to inflation every year.