FBP C19, more depth Flashcards
Debt financing
the process of borrowing money to develop or expand a business / the process of taking out a loan
Principal
the amount of money borrowed
Duration of the bond
is the length of time for which the money is borrowed
Interest
is the additional amount paid in order to get the loan
Bonds
are the primary instrument of debt financing, they represent a promise to repay the loan with interest over a set period of time
Who issues bonds?
- Corporations
- Municipalities
- Governments (foreign or domestic)
Are bonds traded?
Yes. The financial world trades the worth of bonds much like stocks are traded. Bonds are worth their face value + interest.
Bonds represent a security in a corporation
What are bonds also reffered to as
Referred to as “fixed income” instruments of investment
Interest rate
is a yearly % paid on the principal of the loan / Interest represents the extra amount of money needed to entice an investor
Is intrest valuble
Interest rate is valuable in the future especially if other interest rates drop because bonds pay a guaranteed interest rate
How is the value determined?
Value is determined by the interest rate paid on the initial capital investment loan called a principal
When is interest paid?
Interest is paid regularly or in full at the maturation of a bond.
Paperwork of a bond
Like the paperwork of a stock
Types of bonds:
Registered bonds – have interest checks sent to the “registered” owner of the bond. These checks must be endorsed
Coupon bonds – the owner must present coupon to an agent to receive interest payments
Zero coupon bonds – do not pay interest
Registered bonds
have interest checks sent to the “registered” owner of the bond. These checks must be endorsed
Coupon bonds
the owner must present coupon to an agent to receive interest payments
Zero coupon bonds
do not pay interest
Why are bonds a safer investment than stocks:
- They offer a fixed interest rate
- If a company declare bankruptcy the bondholders get paid right after the IRS (claim surpasses both common and preferred stockholders)
Floating bond
when a new bond is offered
Three types of bonds: (based on when they have to be repaid, maturity date)
1) Bonds
- Mature in over 10 years
- Municipalities float bonds to build schools and roads
- Governments float a variety of bonds to finance projects
- Corporations float bonds because they allow for longer repayment terms than would be available through the bank.
2) Notes
- Mature within 1-10 years
- Floated by financial sectors
3) Bills
- Mature under a year
- Only floated by governments because most corporations go to the bank for short term loans
- Terms of repayment too short for municipalities
How is the value of the bond measured?
Par value (actual value of principal) + the projected interest based on the interest rate at the date of issue
Premium bond
if the interest rate is higher than the general interest rate offered on timed deposits
General interest rate
refers to the interest rate offered by banks, other bonds etc. that are timed
High yield / junk bonds
high investment rate as corporations that offer tthen have limited credit worthiness and high risk because there’s a strong possibility that the corporation will default on the bond.
- Can be very profitable
Default
means not paying the interest or the principal
Discount bonds
if the interest rate offered on the bond is lower than the general interest rate
- Bond is sold at less than face value
- When the bond reaches maturity, the investor receives the full face value
- Maturity is when the principal is due to be paid and the bond will be retired
Yield
is the interest of the bond divided over the price of the bond
Yield to maturity
accounts for the amount of interest left to be paid on the bond before the issue is retired.
We can guarantee a bond is paid back in 2 basic ways
- Collateral – the property or assets that can be used to repay the bond in the case of default
- Mortgage-backed bonds – means the bond is secured by property and buildings that have mortgage
Defaulting
failure to repay loan
Asset backed bonds
are guaranteed by collateral
Debentures
non asset backed bonds, backed by the reputation of the company
Bonds may be convertible
- The owner can redeem the bond for a specified amount of stocks
- Once the bond is redeemed for stock you no longer get interest on threat bond as it no longer exists.
- The actual price of stock may be higher when you convert it
Corporate bond
investors who buy cooperate bonds are lending money to the company issuing the bond.
Serial bond
have different maturity dates that stagger the repayment for thr corporation within the same bond issue (used for long term bond issue)
A sinking fund
is a cash reserve that the corporation contributes to regularly and is used to redeem the bond (offers investors a sense of security)
A corporation can rollover the bond issue if it callable
-
Callable bonds
allow corporations to pay off the principle early and no longer be obligated to pay interest payments
Rolling over the debt
the corporation may reissue another bond at a lower interest rate.
Municipal Bonds
debt securities issued by states, cities, counties and other government entities to fund day to day obligations and to finance capital projects such as buildings, schools etc.
Features:
- Tax exempt
- Tax exempt status is on the interest earned and not the principal
- Used to finance local projects
- Tax exemption is granted because the state and fed government is relieved of the costs of the improvements
State issued bonds
Why are they issued:
To finance statewide projects such as unis, hospitals etc.
State issued bonds
How are they taxed?
Most state bonds are double tax exempt because the federal government recognizes that improvements in the business environment of a state can impact the long-term tax base by creating jobs and opportunities.
Treasury bill / T bill
a short dated government security, yielding no interest but issued at a discount on its redemption price.
Treasury bill / T bill
How are they sold?
They are sold at auctions in 500.0K denominations to institutional customers. Bill is sold with no interest attached.
Treasury bill / T bill
How is profit derived?
Is derived from the difference between face value at maturity and actual principal paid at time of purchase
- Risk free
- Redeemable in 3-6 months
- Not callable
- Sold by the treasury department
Government bonds
Investors buy different types of bonds both foreign and domestic
Who are government bonds bought buy:
- Banks
- Pension funds
- Brokerage houses
- Unions
- Governments
Agency bonds
are issued by federal agencies (us government)
Features:
- Finances projects such as housing, energy and highways
- Have verifying degrees of taxability
- US saving bonds are issued in small denominations and mature in 7 years
3 ways investors make money in bonds
Investors make money on bonds in several different ways:
- Cashing in the bond – when t matures (especially profitable in high yield bonds)
- Sheltering income – by buying tax free bonds
- Selling the bond – to other investors based on the yield to maturity, as compared to prevailing interest rates
- Investors sell bonds at a discount if they think the interest rate is too low or low corporation loses its credit rating
- Corporations with lower credit ratings float bonds at higher interest rates
- If the credit rating improves the bond is worth more to the investor
Credit rating
is an assessment of the ability to repay a loan
- Governments have credit ratings
- The lower the credit ratings the higher the interest rate must be in order to attract investors
- Based on the corporations’ statements and other financial documentation
Mutual funds
an investment program funded by shareholders that traders in diversified holdings and is professionally managed.
Features:
- Run by professionals
- Fund combine the monies of many investors and invest in market
- Investors are given shares of the fund called net assets values
- Funds not only buy stock…many funds buy an assortment of investments intraments such as bonds ect.
- Traded once a day at the close of the market
Net asset value
the investor buy a proportion of the fund. The proportion is called the net asset value share.
Net asset value equation
NAV = current market value of fund – liabilities / outstanding shares
Conditions of purchase of funds
Some funds have specific conditions of purchase. These conditions may vary buy they include:
- Required fee to buy into the fund called a loan
- Annual management fees
- Penalty for early withdrawal from funds. Many funds require investors to commit to fund for a specific period usually 3-5 years.
Benefits of investing in mutual funds
- Professional management
- Diversified investment portfolio
- Ability to invest in markets the investors may not feel comfortable investing in, on their own (biotech, emerging markets)
Many funds have specific goals and specialties
- Balanced funds with mix of investments
- Global funds
- Emerging markets
- Aggressive growth
- Income
- Index funds
- Sector funds specialize in specific industry
- Tax shelters
Exchange traded funds
is a mutual fund that is traded on the equity exchange market like a stock
- Usually include a combination of stocks, bonds, real estate investments and cash like a mutual fund
- Unlike a mutual fund they are traded throughout the day like a stock and their value is based on supply and demand rather than N.A.V
