...Bonds are appealing to investors because they provide a generous amount of current income and they can often generate large capital gains. These two sources of income together can lead to attractive and highly competitive investor returns. Bonds make an attractive investment outlet because of their versatility. They can provide a conservative investor with high current income or they can be used aggressively by investors who prefer capital gains. Given the wide and frequent swings in interest rates, investors can find a variety of investment opportunities. In addition to their versatility, certain types of bonds can be used to shelter income from taxes. While municipal bonds are perhaps the best known tax shelters, some Treasury and federal agency bonds also give investors some tax advantages. Bonds are exposed to the following five major types of risk: (1) Interest rate risk: This affects the market as a whole and therefore translates into market risk. When market interest rates rise, bond prices fall, and vice versa. (2) Purchasing power risk: This is the risk caused by inflation. When inflation heats up, bond yields lag behind inflation rates. A bond investor is locked into a fixed-coupon bond even though market yields are rising with inflation. (3) Business/financial risk: This refers to the risk that the issuer will default on interest and/or principal payments. Business risk is related to the quality and integrity of the issuer, whereas financial risk relates to the amount...
Words: 15669 - Pages: 63
...BONDS AND SINKING FUNDS Amortization of Bond Premiums and Discounts *APPENDIX: The origin and calculation of bond premiums and discounts were discussed in Section 15.2. We will now look at the premiums and discounts from an accountant’s perspective. The point of view and the schedules developed here provide the basis for the accounting treatment of bond premiums, discounts, and interest payments. Amortization of a Bond’s Premium Bonds are priced at a premium when the coupon rate exceeds the yield to maturity required in the bond market. Suppose that a bond paying a 10% coupon rate is purchased three years before maturity to yield 8% compounded semiannually. The purchase price that provides this yield to maturity is $1052.42. The accounting view is that a period’s earned interest is the amount that gives the required rate of return on the bond investment. The interest payment after the first six months that would, by itself, provide the required rate of return (8% compounded semiannually) on the amount invested is 0.08 ϫ $1052.42 ϭ $42.10 2 The earned interest during the first six months from an accounting point of view is $42.10. The actual first coupon payment of $50 pays $50 Ϫ $42.10 ϭ $7.90 more than is necessary to provide the required rate of return for the first six months.7 The $7.90 is regarded as a refund of a portion of the original premium, leaving a net investment (called the bond’s book value) of $1052.42 Ϫ $7.90 ϭ $1044.52 This book...
Words: 1917 - Pages: 8
...Vincent Murphy 4/14/14 There are many great ways to invest your hard earned money; this can be done through stocks and bonds. With stocks and bonds you can invest in companies, governments or even your local bank. In this report I will tell three of the most common and efficient ways to invest your finances, They are common stock, preferred stock and company bonds. Common stock allows you to be a part owner of a company along with other stock holders. Being a part owner comes with one major benefit, the ability to elect the board of directors. Lastly you could potentially earn dividends paid out by the company. Unlike preferred stocks the dividend that are not promised to common stock holders. This now brings me to the second popular investment tool Preferred stocks. With preferred stocks you are not the owner of the company, this means you have no voting rights. Even though you are not an owner you do receive preferential treatment in receiving dividends. This means that the company that you own stock in will ensure that you receive dividends before the common stock owners. Lastly, another incentive for owning preferred stock is that the dividends are given at a fixed rate. The last investment option I will talk about is company bonds. Company bonds work off of collateral, to help insure you get your money if the company fails. There is two types of collateral, mortgage and equipment. With mortgage collateral if anything was to happen to the company you would be...
Words: 390 - Pages: 2
... a) Bond – is a long term contract under which the borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. Treasury bonds – sometimes referred to as government bonds, are issued by the U.S. federal government. These bonds have not default risk. However, these bonds decline when interest rates rise, so they are not free of all risk Corporate bonds – issued by corporate; exposed to default risk – if the issuing company gets into trouble, it may be unable to make the promised interest and principal payments. Different corporate bonds have different levels of default risk, depending on the issuing company’s characteristics and the terms of the specific bond. Default risk often referred to as “credit risk” and the larger the default or credit risk, the higher the interest rate the issuer must pay. Municipal bond – or “munis “ are issued by state and local governments. Like corporate bonds, munis have default risk. Munis offer one major advantage over all the other bonds is exempt from federal taxes and also from state taxes if the holder is a resident of the issuing state. Munis bonds carry interest rates that are considerably lower than those on corporate bonds with the same default risk Foreign bond – are issued by foreign governments or foreign corporations. Foreign corporate bonds are of course exposed to default risk, and so are some foreign government bonds. An additional risk exists if the bonds are denominated...
Words: 1835 - Pages: 8
...------------------------------------------------- Top of Form Bottom of Form * Bond Markets / Prices * Commentary * Learn More * Overview * Bond Basics * What You Should Know * Buying and Selling Bonds * Types of Bonds * Strategies * Bonds at Your Stage of Life * About Municipal Bonds * About Government/Agency Bonds * About Corporate Bonds * About MBS/ABS * How to Use This Site * Links to Other Sites Learn More * Overview * Bond Basics * What You Should Know * Overview * The Role of Bonds in America * Investor's Checklist * Investor Protection * Asset Allocation * Reading Bond Prices In the Newspaper * Understanding Economic Statistics * Bond and Bond Funds * Risks of Investing in Bonds * Rating Changes and Your Investments * Corporate Bankruptcy & Your Investment * Selecting and Working with a Financial Professional * Rising Rates and Your Investments * Tax Tables * Buying and Selling Bonds * Types of Bonds * Strategies * Bonds at Your Stage of Life * About Municipal Bonds * About Government/Agency Bonds * About Corporate Bonds * About MBS/ABS * How to Use This Site * Links to Other Sites What You Should Know * Print * Email Risks of Investing in Bonds All investments offer a balance between risk and potential return. The...
Words: 2099 - Pages: 9
...Bond Valuation By Anuj Joshi Note 1 Bond Valuation Fixed income paying securities. 1. Theoretical price or value of bond depends upon. i. Coupon Payment : Fixed amount of interest to be received after prescribed frequency. ii. Maturity Value [Unless otherwise given is exam, we should take face value] iii. Discount Rate : It should always be market interest rate 2. What is market interest rate Market interest rate is derived from comparable listed bond. The comparison is based on risk and life of the bond. E.g. If we are valuing a bond which is unlisted and have 5 years of life, then we should look for a bond which is similar in risk profile (i.e. same credit rating)and having similar life. The YTM (Yield to Maturity) of listed bond is called market interest rate The YTM of a bond is nothing but IRR of the bond. 3. Value of a bond = PV of Coupon Amount + PV of Maturity Value [Remember CF and discount rate are before tax] Concept Point: i. Coupon rate is a historical rate and should never be used as a discount rate. In exam, if no other information is available, then only we should assume coupon rate of interest as market rate of interest. ii. Remember, Cost of Capital or Discount Rate is a future concept and it represents opportunity cost on the date of valuation. iii. YTM of a similar bond (i.e. current market interest rate) is the appropriate discount rate for bond valuation. How to value a bond which pays interest at a frequency lower than annually (e...
Words: 2748 - Pages: 11
...Chapter 7(13E) Bonds and Their Valuation Answers to End-of-Chapter Questions 7-1 From the corporation’s viewpoint, one important factor in establishing a sinking fund is that its own bonds generally have a higher yield than do government bonds; hence, the company saves more interest by retiring its own bonds than it could earn by buying government bonds. This factor causes firms to favor the second procedure. Investors also would prefer the annual retirement procedure if they thought that interest rates were more likely to rise than to fall, but they would prefer the government bond purchase program if they thought rates were likely to fall. In addition, bondholders recognize that, under the government bond purchase scheme, each bondholder would be entitled to a given amount of cash from the liquidation of the sinking fund if the firm should go into default, whereas under the annual retirement plan, some of the holders would receive a cash benefit while others would benefit only indirectly from the fact that there would be fewer bonds outstanding. On balance, investors seem to have little reason for choosing one method over the other, while the annual retirement method is clearly more beneficial to the firm. The consequence has been a pronounced trend toward annual retirement and away from the accumulation scheme. 7-2 Yes, the statement is true. 7-3 False. Short-term bond prices are less sensitive than long-term bond prices to interest rate changes...
Words: 9484 - Pages: 38
...Bond Yields Interest rates have a big part in determining the yield of a bond. If interest rates rise, the bond will be worth less and if they fall bonds will be worth more. The Yield to Maturity or YTM is the rate of return the lender or borrower will earn if the bond is not sold before its maturity. It can be also referred to as the bond`s yield. In order to be able to calculate the Yield to Maturity, some of the things you would need to know are the current price, the par value, the interest payments, and the maturity date for the bond. A coupon is the stated interest payment made on a bond. The market value will be less than par value if the required rate of return is above the coupon interest rate. Bond will be valued above pay value if the required rate of return is below the coupon interest rate. Also, the lower the coupon rate the greater the interest rate risk. Interest rate risk refers to the risk of fluctuating interest rates. In other words, bond values have an inverse relationship to interest rates. Long-term bonds will have a greater interest rate risk than short-term bonds. Interest rates have a greater impact on long-term bonds because it takes longer for them to mature. Typically, the more you can earn from a bond the more risk there is to it. However, the more risk there is to a bond the more likely either the borrower might default. Bonds have a rating system which gives them a rating based on the likelihood...
Words: 1045 - Pages: 5
...Bond Market INTRODUCTION Presently, as there is a robust growth of industrial activity in our economy, the need for investment has grown significantly and has resulted in a strong credit growth Some disintermediation is expected to take place as the most creditworthy borrower seeks the lowest borrowing costs. This development has re-emphasized the fact that bond financing has to supplement the traditional bank financing to take care of the growing credit needs of the economy. The Indian debt market, particularly the government securities market, has undergone a significant transformation since the introduction of reforms in the financial markets in 1991-92. The primary objective behind the reforms has been to moderate liquidity growth, contain inflationary pressure, and conduct public debt management in a cost-effective manner. Various reforms have also been undertaken in the corporate debt market. The corporate bond market is an important segment of the financial market in terms of funds raised well as potential for future growth. The Securities and Exchange Board of India (SEBI) was established in 1992, to regulate the primary issue in equity and de markets and to ensure sound trading practices in the secondary market throu stock exchanges. The bond market is an important source of funding for both t government and corporate sector. The bond market, also known as the debt, credit, or fixed income market, is a market where participants buy and sell debt securities...
Words: 6265 - Pages: 26
...Bonds are a written record of a debt. The borrower sells a bond in return for a loan. The holder of a bond receives interest payments and the final repayment. Bonds can also be sold in secondary financial markets. Bonds can also be referred to as fixed-income securities. They are long term securities for lenders to receive regular fixed payments (coupon payments), from the issuing institution, and receive the principle value of the debt (face value of bond), at the end of the bond period (date maturity). Bonds are issued by a small number of companies and banks. * Bonds are a special type of loan taken put by the governments and large companies. * This form of debt security is a written financial document issued by the borrower to the lender, individual or company, aka the “bondholder”. * The initial price of bond is the size of the loan (face value) * The bondholder is entitled to a fixed stream of income payments (coupon). These repayments lead to the initial loan amount when the bond matures. * The “yield” (rate of financial return on a bond), is calculated by dividing the coupon payment by the bond price. * If interest rates across the economy increase then the yield on the bond will also increase.This higher yield will lead to lower price for the bond. Visa Versa. * Therefore, the price of bonds will fluctuate according to changes in levels of interest rates. Aussie bonds yield biggest gains for global investors July...
Words: 535 - Pages: 3
...experienced a growth in sales for the last 5 years. This increase in revenues is a good indicator that the company is experiencing growth. Apple’s Debt/Equity ratio shows that Apple is primarily financed by equity. Apple raised 17 billion in debt as of April 2013 making the company’s capital structure change from purely equity to 87% equity. This is well below the industry average of 70% equity 30% debt. Raising debt was a tactical move on Apple’s side to lower tax expenses. It’s timing is also relevant. By issuing debt when they did, Apple took advantage of the low interest rates the market is offering. Furthermore Apple is a safe investment because of the low liabilities and high assets the company possesses. Apple’s 10-year corporate bonds are currently...
Words: 391 - Pages: 2
...Bond Concepts: Bond Pricing It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run through some bond price calculations for various types of bond instruments. Bonds can be priced at a premium, discount, or at par. If the bond's price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bond's price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond's coupon rate in comparison to the average rate most investors are currently receiving in the bond market. Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates. Fundamentally, however, the price of a bond is the sum of the present values of all expected couponpayments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) - which is based on the assumption that each payment is re-invested...
Words: 2611 - Pages: 11
...Corporate bonds have had a long thriving history in the fixed income market. The first corporate bond issued dates back to the construction of railroads after the conclusion of the Civil War. Increasing in popularity each year, the corporate bond issuance rate has been on a steady incline with daily trading in the billions. Corporate bonds are very complex but simple enough to where everyone can increase their wealth by investing in them. Essentially corporate bonds are debt that a company issues to the investor. Issued by either a private or public company, companies use these funds to build facilities, buy equipment and/ or expand their business. These businesses are typically public utilities, transportation companies, industrial corporations, and financial services companies. Investors may invest in corporate bonds when they see an opportunity to make a profit and/or to diversify their portfolio. A risk-averse investor would love corporate bonds because of their predictable returns, dependable income, flexibility and diversification. There are many different types of corporate bonds for the investor to invest in. They have the option to invest in Eurobonds, Rule 144A bonds, Yankee Bonds, and many other options. Although there are many different types of corporate bonds, Eurobonds are one of the most popular ways for a company to issue debt. A Eurobond is a U.S. denominated bond that is issued by an oversees company and held in a foreign institution outside both the U.S...
Words: 1263 - Pages: 6
...on callable bonds is(are): Choose one answer. | a. The bondholders. | | | b. The bond issuer. | | | c. The bond indenture. | | | d. The bond trustee. | | | e. The bond underwriter. | | Correct Marks for this submission: 1/1. Question2 Marks: 1 To provide security to creditors and to reduce interest costs, bonds and notes payable can be secured by: Choose one answer. | a. Safe deposit boxes. | | | b. Mortgages. | | | c. Equity. | | | d. The FASB. | | | e. Debentures. | | Correct Marks for this submission: 1/1. Question3 Marks: 1 A company issued 5-year, 7% bonds with a par value of $100,000. The market rate when the bonds were issued was 6.5%. The company received $101,137 cash for the bonds. Using the straight-line method, the amount of recorded interest expense for the first semiannual interest period is: Choose one answer. | a. $3,386.30. | | | b. $3,500.00. | | | c. $3,613,70. | | | d. $6,633.70. | | | e. $7,000.00. | | Correct Marks for this submission: 1/1. Question4 Marks: 1 On January 1 of Year 1, Drum Line Airways issued $3,500,000 of par value bonds for $3,200,000. The bonds pay interest semiannually on January 1 and July 1. The contract rate of interest is 7% while the market rate of interest for similar bonds is 8%. The bond premium or discount is being amortized at a rate of $10,000 every six months. The amount of interest expense recognized by Drum Line Airways on the bond issue in Year...
Words: 1010 - Pages: 5
...Stocks and Bonds People all over the world purchase stocks and bonds everyday form many different companies. A person’s financial goals, business interests, or current wealth are factors in helping them decide how much to invest in stocks or when to purchase bonds. The main difference between stocks and bonds; is stocks equal equity while bonds equal debt. A person buying stock in a company usually has a desire to own part of that corporation or business, whereas a person buying bonds will become a creditor to that company and usually has wants no decision making responsibilities. Apple, Inc. is one of the worlds richest companies and its stock prices has had a roller-coaster ride since Steve Jobs and Steve Wozniak founded it in 1976. On the other hand, the purchase of U.S. Treasury Bonds by bondholders has had a long history of helping America in the country’s times of need, especially during wars and other financial recessions. Buying bonds has also helped many Americans save for their retirement years or helped put their children through college. Apple began in a garage when both men had to sell their personal items and take out loans just to fulfill their first order of the Apple 1 computers they sold. Since then Apple has become one of the largest revenue companies in the world and is changing people’s lives everyday with their technology and products. Just like many other companies in the world Apple’s stock has had both good and bad years over the last twenty years,...
Words: 1126 - Pages: 5
