keown_pf5_ch14.ppt
DESCRIPTION
Keown_PF5_CH14.pptTRANSCRIPT
Investing in Bonds and Other
Alternatives
14-2Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Learning Objectives
1. Invest in the bond market.
2. Understand basic bond terminology and compare the various types of bonds.
3. Calculate the value of a bond and understand the factors that cause bond value to change.
14-3Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Learning Objectives
4. Compare preferred stock to bonds as an investment option.
5. Understand the risks associated with investing in real estate.
6. Know why you shouldn’t invest in gold, silver, gems, or collectibles.
14-4Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Introduction
Bonds carry less risk than stocks.
Bonds provide steady income.
But returns from bonds are not necessarily low.
14-5Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Why Consider Bonds?
Bonds reduce risk through diversification.
Bonds produce steady income.
Bonds can be a safe investment if held to maturity.
14-6Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Basic Bond Terminologyand Features
Par value
Maturity
Coupon Interest Rate
Indenture
14-7Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Basic Bond Terminologyand Features
Indenture – a legal document that provides specific terms of the loan agreement.
It includes: A description of the bond. The rights of bondholders. The rights of the issuing firm. The responsibilities of the bond trustees.
14-8Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Basic Bond Terminologyand Features
Call Provision
Deferred call
Sinking Fund
14-9Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Corporate Bonds
Corporate bonds
Secured corporate debt Mortgage bond
Unsecured corporate debtDebenture
14-10Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Treasury and Agency Bonds
Risk-free
Not callable
Lower interest rate
Most interest payments are exempt from state and local taxes.
14-11Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Treasury and Agency Bonds
Treasury-issued debt has maturities from 3 months to 10 years.
Bills, notes, and bonds differ by maturity and denomination.
Agency bonds
14-12Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Treasury and Agency Bonds
Pass-through certificates issued by the Government National Mortgage Association “Ginnie Mae”
Treasury Inflation Protected Securities (TIPS)—par value changes with the consumer price index to guarantee investor a real rate of return
14-13Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Treasury and Agency Bonds
U.S. Series EE Bonds
I Bonds
14-14Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Municipal Bonds
“Munis”—issued by states, counties, cities, public agencies e.g. school districts
General obligation bond
Revenue Bonds
Serial maturities
14-15Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Special Situation Bonds
Zero Coupon Bonds—don’t pay interest and are sold at a deep discount from their par value
Junk Bonds—also high-yield bonds, very risk, low-rated BB or below
14-16Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Bond Ratings – A Measureof Riskiness
Moody’s and Standard & Poor’s provide ratings on corporate and municipal bonds.
Ratings involve a judgment about a bond’s future risk potential.
The poorer the rating, the higher the rate of return demanded by investors.
Safest bonds receive AAA, D is extremely risky.
13-17Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
14-18Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Bond Yield
Current Yield—ratio of annual interest payment to the bond’s market price.
Yield to maturity—true yield or return that the bondholder receives if a bond is held to maturity—measure of expected return
Equivalent taxable yield on municipal bonds
14-19Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Valuation Principles
Principle 3—time value of money
Principle 8—risk and return go hand in hand
Value in today’s dollars of the interest payments and principal payments, add them together.
14-20Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Bond Valuation
The value of a bond is the present value of the interest payments plus the present value of the repayment of the bond’s par value at maturity
14-21Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Bond Valuation
If the issuer becomes riskier, the required rate of return should rise.
A change in general interest rates, the required rate of return should increase.
When interest rates rise, the value of outstanding bonds falls.
14-22Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Why Bonds Fluctuate in Value
Inverse relationship between interest rates and bond values in the secondary market.
When interest rates rise, bond values drop, and when interest rates drop, bond values rise
Longer-term bonds fluctuate in price more than shorter-term bonds.
13-23Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Figure 14.1
13-24Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
14-25Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Why Bonds Fluctuate in Value
As a bond approaches maturity, the market value approaches its par value.
When interest rates go down, bond prices go up, but upward price movement on bonds with a call provision is limited by the call price.
13-26Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
13-27Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
14-28Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
What Bond Valuation Relationships Mean to the Investor
If you expect interest rats to go up (bond prices to fall)—purchase very short-term bonds
If you expect interest rates to go down (bond prices to rise)—purchase bonds with long maturities and are not callable.
14-29Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Reading Corporate Bond Quotes in the Wall Street Journal Online
Selling price is quoted as percentage of par.
Also expected to pay accrued interest
Invoice price—sum of the quoted or stated price of a bond and the bond’s accrued interest—price of bond on secondary market.
13-30Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
14-31Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Preferred Stock—An Alternative to Bonds
A hybrid security with features of common stock and bonds.
Similar to common stock—no fixed maturity date, not paying dividends won’t bring bankruptcy.
Similar to bonds—dividends are fixed, paid before common and no voting rights.
14-32Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Features and Characteristicsof Preferred Stock
Multiple Issues
Cumulative Feature
Adjustable Rate
Convertibility
Callability
14-33Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Valuation of Preferred StockThe value of a share of preferred stock is the
present value of the perpetual stream of constant dividends.
Value of preferred stock= annual preferred stock dividend
required rate of return
As market interest rates rise and fall, the value of preferred stock moves in an opposite manner
14-34Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Risks Associated withPreferred Stock
If interest rates rise, the value of preferred stock drops.
If interest rates drop, the value of preferred stock rises and it is called away.
14-35Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Risks Associated withPreferred Stock
Investor does not participate in the capital gains that common stockholders receive.
Investor doesn’t have the safety of bond interest payments, preferred dividends can be passed without the risk of bankruptcy.
14-36Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Investing in Real Estate
Requires time, energy and sophistication.
Direct investments in real estate
Indirect investments in real estate
Investing in real estate: the bottom line
14-37Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Investing – Speculating in Gold, Silver, Gems, and Collectibles
Don’t do it!
This is not investing – it is speculation.
Collectibles may only have entertainment value.
Don’t expect them to provide for your financial future.
14-38Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Summary
Bonds reduce risk, produce steady income, and can be safe investment.
Hold bond until it matures—can get yield to maturity.
Value of bond is the present value of the stream of interest payments plus the present value of the repayment of the bond’s par value at maturity
14-39Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
Summary
Preferred stock is a security with no fixed maturity date and with dividends that are generally set in amount and don’t fluctuate.
You own property with direct real estate investment but with indirect real estate investment, you’re an investor in a group.
Gold, silver, gems or collectibles are not investments but speculation.