Chapter 11: Financial Markets Section 4: Bonds & Other Financial Instruments pgs.338-343

1. Chapter 11:Financial MarketsSection 4: Bonds & Other Financial Instrumentspgs.338-343

2. Key Concepts • A bond is a contract by a corporation or the government promising to repay borrowed money, plus interest, on a fixed schedule. • The amount that the bond issuer promises to pay the buyer at maturity is its par value. • Maturity is the date the bond is due to be repaid. • The coupon rate is the interest rate a bondholder receives every year until a bond matures. • The yield is the annual rate of return.

3. Why Buy Bonds? • There are two reasons to invest in bonds—the interest paid on bonds and the gains made by selling bonds. • Most people buy bonds for the interest. • Generally, bonds are considered less risky than stocks b/c bondholders are paid before stockholders. • Generally speaking, bonds with longer maturity dates have higher yields than shorter dates, b/c they are seen as having higher risk.

4. Types of Bonds—U.S. Government Securities • Bonds are classified on who issues the bonds. • The U.S. Government issues securities called Treasury bonds, notes, or bills. • Treasury bonds help keep the federal government operating. • Treasury bonds have the longest maturity (more than ten years) and Treasury bills having the shortest (one year or less). • They are backed with the “full faith and credit” of the federal government they are considered risk free.

5. Types of Bonds—Municipal Bonds • Bonds issued by the state and local governments are called municipal bonds. • Funds raised by these bonds finance government projects such as construction of roads, bridges, school and other public facilities. • The interest earned on these bonds is tax free. • These are usually seen as risk free but there have been states and cities that went bankrupt .

6. Types of Bonds—Corporate Bonds • These bonds help businesses expand. • These bonds generally pay a higher coupon rate than government bonds b/c the risk is higher. • One kind of corporate bond, a junk bond, is considered high risk but has the potential for high yields. • The risk involved with investing in junk bonds is similar to that of investing in stocks.

7. Buying Bonds • Most investors purchase bonds b/c they want the guaranteed interest income. • Investors who want to sell bonds before they reach maturity study the bond market to see if they can sell their investment at a profit. • The main risk that bond buyers face is that the issuer will default. • This is why Moody’s and Standard & Poor’s and others rate the bonds from AAA to junk status.

8. Other Financial Instruments • We have already talked about Certificates of Deposit (CDs). You have to leave your money in the account 6 months to 5 years and then you get much better interest rates. • Another investment is Money Market Mutual Funds, which allow investors to own a variety of short-term financial assets, such as Treasury bills, municipal bonds, large-denomination CDs, and corporate bonds. These mutual funds yield higher than bank accounts, but provide a similar level of liquidity. There is less risk than a CD b/c the money is not committed for a specified length of time.