When you buy bonds you are a creditor.

When you buy stock you are an owner.

The Bond market is also called fixed income market

Types of Bonds:

Most bond issuers are government agencies.

    US Treasury bonds = 10 years or more
    US Treasury notes = between 1 and 10 years
    US Treasury Bills = 1, 3, 6, or 9 months

Treasuries are default free securities

Municipal bonds = State and local government

Corporate bonds = Obligations to corp.
    Investment grade = high quality credit
    Junk bonds = low quality credit

There are mutual funds for all of these types of bonds

All bonds are subject to interest rate risk

Speculators become forecasters of interest rate changes.  Speculators are of course willing to take risks.

All bonds are susceptible to interest rate change

Increase in interest rates = decrease in bond prices

Decrease in interest rates = increase in bond prices

Conservative investors – just want their yield.  They are holding the bond until maturity so price changes do not matter to them.

The Duration of a bond is always less than the maturity of the bond

The higher the duration the more interest rate risk you are taking

If interest rates are going to fall you want to be holding bonds with the highs duration.  (Short high duration bonds in interest rates will rise)

The farther away maturity is the higher duration
The lower the coupon is the higher duration.

Zero Coupon bonds have the highest duration.

Long term government bond rates:

Mid 50’s = 2.5%
Mid 60’s = 4%
Early 70’s = 7%
Mid 70’s = 8%
Early 80’s = 15%
Mid 80’s = 10%
Early 90’s = 8%
Mid 90’s =  7%

Current rate = 6.0%

Are bonds taxable?

Treasury bonds, bills, notes, are taxed federally but not state or locally.

Zero coupon = tax imputed (usually used in IRA or pension (so they are nontaxable)

GNMA = fully taxable

Muni bonds – no fed tax – no state tax if resident.  Better for high tax bracket investors

Capital gains are of course are taxable

Equivalent taxable investment = Municipal yield / (1 – marginal tax rate)

Corporate bonds are taxable (callable also)

Other bond info:

Bonds have more offerings than common stock

Bond indenture – major bond provisions

Corp. bond have $1,000 par values
State. Local, fed have $5 – 10,000 par value

Perpetual bonds never get paid off

Serial payments- bonds are paid off in installments over life of the issue.  Municipal bonds often issued on this basis

Sinking funds – Corp. makes contributions for a fund to buy back bonds out of market

Call provision – usually deferred for 5 years and usually corp. pays a 5 – 10% premium

Put provision – if interest rates go up, investor can sell back bond at par value after 3 – 5 years

With corporate bonds, the right of the corporation to call the bond is a prepayment risk.  Municipal bonds have prepayment risk also

Treasuries have no prepayment risk