Define how stocks, bonds and investments play a role in the financial future of a for profit and non profit organization?
Define how stocks, bonds and investments play a role in the financial future of a for profit and non profit organization? How does the overall market play into this? Using your company from previous(APPLE) and an additional company. There will need to be equations used, you decide which ones, show your math and explain why you chose those. Be very descriptive.
This paper will be no less than 3 pages and that should not include the title and reference section.
Reading Chapter 7 and 8 in the text will assist you in writing this discussion forum.
Watching the video Interest Rates will assist you in writing this discussion forum.
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Requirements: in-depth example
How do you even purchase a bond in the first place?226cor91411_ch07_226-263.indd 226 01/20/17 06:58 PMValuing Bonds7PART FOURviewpointsBusiness ApplicationYou are the chief financial officer (CFO) for Beach Sand Resorts. The firm needs $150 million of new capital to renovate a hotel property. As you discuss the firmÕs plans with a credit rating agency, you learn that if 15-year bonds are used to raise this capital, the bonds will be rated BB and will have to offer a 7 percent return. How many bonds will you have to issue to raise the necessary capital? What semiannual interest payments will Beach Sand have to make? (See the solution at the end of the chapter.)Personal ApplicationYou would like to invest in bonds. Your broker suggests two different bonds. The first, issued by Trust Media, will mature in 2023. Its price is quoted at 96.21 and it pays a 5.7 percent coupon. The second bond suggested, issued by Abalon, Inc., also matures in 2023. This bondÕs price is 101.94 and pays a 5.375 percent coupon. To help you decide between the bonds, you want to know how much money it will cost to buy 10 bonds, what interest payments you will receive, and what return the bonds offer if purchased today. Also, you want to understand the differences between what the two bonds imply about their risk. (See the solution at the end of the chapter.)Final PDF to printer
227cor91411_ch07_226-263.indd 227 01/20/17 06:58 PMLearning GoalsHow important are bonds and the bond market to a capital-ist economy? Those unfamil-iar with the financial markets may have the impression that the stock market dominates capital markets in the United States and in other coun-tries. Stock market performance appears constantly on 24-hour TV news channels and on the evening news. By contrast, we seldom hear any mention of the bond market. While bonds may not generate the same excitement that stocks do, they are an even more important capital source for companies, governments, and other organizations. The bond market is actually larger than the stock market. At the end of 2015, the U.S. bond market represented roughly $39.6 trillion in outstanding debt obligations. At the same time, the market value of all common stock issues was worth just over half of the value of the bond market, at roughly $21.0 trillion.Bonds also trade in great volume and frequency. During 2015, the total average daily trading in all types of U.S. bonds reached over $730 billion. Investors are often attracted to the stock market because it offers the potential for high investor returnsÑbut great risks come with that high potential return. While some bonds offer safer and more stable returns than stocks, other bonds also offer high potential rewards and, conse-quently, higher risk.In this chapter, we will explore bond characteristics and their price dynamics. You will see that bond pricing uses many time value of money principles that weÕve used in the preceding chapters. LG7-1 Describe bond characteristics. LG7-2 Identify various bond issuers and their motivation for issu-ing debt. LG7-3 Read and interpret bond quotes. LG7-4 Compute bond prices using present value concepts. LG7-5 Explain the relationship between bond prices and interest rates. LG7-6 Compute bond yields. LG7-7 Find bond ratings and assess credit riskÕs effects on bond yields. LG7-8 Assess bond market performance.© Royalty-Free/CorbisFinal PDF to printer
228 part four Valuing of Bonds and Stockscor91411_ch07_226-263.indd 228 01/20/17 06:58 PM7.1 ∙ Bond Market OverviewBond CharacteristicsBonds are debt obligation securities that corporations, the federal government or its agencies, or states and local governments issue to fund various projects or operations. All of these organizations periodically need to raise capital for various reasons, which was formally discussed in Chapter 6. Bonds are also known as fixed-income securi-ties because bondholders (investors) know both how much they will receive in inter-est payments and when their principal will be returned. From the bond issuerÕs point of view, the bond is a loan that requires regular interest payments and an eventual repay-ment of the borrowed principal. InvestorsÑoften pension funds, banks, and mutual fundsÑbuy bonds to earn investment returns. Most bonds follow a relatively standard structure. A legal contract called the indenture agreement outlines the precise terms between the issuer and the bondholders. Any bondÕs main characteristics include: ¥ The date the principal will be repaid (the maturity date). ¥ The par value, or face value, of each bond, which is the principal loan amount that the borrower must repay. ¥ The coupon (interest) rate. ¥ A description of any property to be pledged as collateral. ¥ Steps that the bondholder can take in the event that the issuer fails to pay the inter-est or principal.Table 7.1 describes par value and other bond characteristics. Most bonds have a par value of $1,000. This is the amount of principal the issuer has promised to repay. Bonds have fixed lives. The bondÕs life ends when the issuer repays the par value to the buyer on the bondÕs maturity date. Although a bond will mature on a specific calendar date, the bond is usually referenced by its time to maturity, that is, 2 years, 5 years, 20 years, and so on. In fact, the market groups bonds together by their time to maturity and classifies them as short-term bonds, medium-term bonds, or long-term bonds, regardless of issuer. Long-term bonds carry 20 or 30 years to maturity. Of course, over time, the 30-year bond becomes a 20-year bond, 10-year bond, and eventually matures. But other time periods to maturity do exist. For example, in 2011, the railroad company Norfolk Southern Corp. issued $400 million of bonds with 100 years to maturity. The bonds have a coupon (inter-est) rate of 6 percent and mature in 2111.When interest rates economywide fall several percentage points (which often takes several years), homeowners everywhere seek to refinance their home mortgages. They want to make lower interest payments (and sometimes want to pay down their mortgage principal) every month. Corporations that have outstanding bond debt will also want to refinance those bonds. Sometimes the indenture contract (the legal contract between a bond issuer and bondholders) allows companies to do so; sometimes the indenture pro-hibits refinancing. Bonds that can be refinanced have a call feature, which means that the issuer can ÒcallÓ the bonds back and repay the principal before the maturity date. To com-pensate the bondholders for getting the bond called, the issuer pays the principal and a call premium. The most common call premium is one yearÕs worth of interest payments. In some indentures, the call premium declines over time.The bondÕs coupon rate determines the dollar amount of interest paid to bondhold-ers. The coupon rate appears on the bond and is listed as a percentage of the par value. So a 5 percent coupon rate means that the issuer will pay 5 percent of $1,000, or $50, in interest every year, usually divided into two equal semiannual payments. So a 5 per-cent coupon bond will pay $25 every six months. Companies set the coupon rate as the prevailing market interest rate at the time of bond issue. The name coupon is a holdover from the past, when bonds were actually issued with a coupon book. Every six months a bondholder would tear out a coupon and mail it to the issuer, who would then make the LG 7-1bondsPublicly traded form of debt.fixed-income securitiesAny securities that make fixed payments.principalFace amount, or par value, of debt.indenture agreementLegal contract describing the bond characteristics and the bondholder and issuer rights.maturity dateThe calendar date on which the bond principal comes due.par valueAmount of debt borrowed to be repaid; face value.time to maturityThe length of time (in years) until the bond matures and the issuer repays the par value.callAn issuer redeeming the bond before the scheduled maturity date.call premiumThe amount in addition to the par value paid by the issuer when calling a bond.coupon rateThe annual amount of inter-est paid expressed as a percentage of the bondÕs par value.Final PDF to printer
chapter 7 Valuing Bonds 229cor91411_ch07_226-263.indd 229 01/20/17 06:58 PMinterest payment. These are sometimes referred to as bearer bonds (often a feature of spy or mystery movies), because whoever held the coupon book could receive the payments. Nowadays, issuers register bond owners and automatically wire interest payments to the ownerÕs bank or brokerage account. Nevertheless, the term coupon persists today.At original issue, bonds typically sell at par value, unless interest rates are very volatile. Bondholders recoup the par value on the bondÕs maturity date. How-ever, at all times in between these two dates, bonds might trade among investors in the secondary bond market. The bondÕs price as it trades in the secondary market will not likely be the par value. Bonds trade for higher and lower prices than their par values. WeÕll thoroughly demonstrate the reasons for bond pricing in a later sec-tion of this chapter. Bond prices are quoted in terms of percent of par value rather than in dollar terms. Sources of trading information list a bond that traded at $1,150 as 115, and a bond that traded for $870 as 87.TABLE 7.1 Typical Bond FeaturesCharacteristicDescriptionCommon ValuesPar valueThe amount of the loan to be repaid. This is often referred to as the principal of the bond.$1,000Time to maturityThe number of years left until the maturity date.1 year to 30 yearsCallThe opportunity for the issuer to repay the principal before the maturity date, usually because interest rates have fallen or issuerÕs circumstances have changed. When calling a bond, the issuer commonly pays the principal and one year of interest payments.Many bonds are not callable. For those that are, a common feature is that the bond can be called any time after 10 years of issuance.Coupon rateThe interest rate used to compute the bondÕs interest payment each year. Listed as a percentage of par value, the actual payments usually are paid twice per year.2 to 10 percentBond priceThe bondÕs market price reported as a percentage of par value.80 to 120 percent of par valuebond priceCurrent price that the bond sells for in the bond market.MATH COACH PERCENT-TO-DECIMAL CONVERSIONSWhen discussing interest rates or using them in calculator or spread-sheet time value of money functions, the value should be in percent (%) form, like 2.5%, 7%, and 11%. When using interest rates in formu-las, the value needs to be in decimal form, like 0.025, 0.07, and 0.11.To convert between the two forms of representing an interest rate, use Decimal = Percent ( % ) __________ 100 EXAMPLE 7-1Bond CharacteristicsConsider a bond issued 10 years ago with an at-issue time to maturity of 30 years. The bondÕs coupon rate is 8 percent and it currently trades in the bond market for 109. Assum-ing a par value of $1,000, what is the bondÕs current time to maturity, semiannual interest payment, and bond price in dollars?SOLUTION: Time to maturity = 30 years − 10 years = 20 years Annual payment = 0.08 × $1,000 = $80, so semiannual payment is $40 Bond price = 1.09 × 1,000 = $1,090 Similar to Problems 7-1, 7-2, 7-3, 7-4, Self-Test Problem 1LG7-1 Bond IssuersFor many years, bonds were considered stodgy, overly conservative investments. Not anymore! The fixed-income industry has seen tremendous innovation in the past couple LG7-2 For interactive versions of this example, log in to Connect or go to mhhe.com/Cornett4e.Final PDF to printer
230 part four Valuing of Bonds and Stockscor91411_ch07_226-263.indd 230 01/20/17 06:58 PMof decades. The financial industry has created and issued many new types of bonds and fixed-income securities, some with odd-sounding acronyms, like TIGRs, CATS, COU-GRs, and PINEs, all of which are securities based on U.S. Treasuries. Even with all the innovation, the traditional three main bond issuers remain: U.S. Treasury bonds, corpo-rate bonds, and municipal bonds. Figure 7.1 shows the amount of money that these bond issuers have raised each year.TREASURY BONDS Treasury bonds carry the Òfull-faith-and-creditÓ backing of the U.S. government and investors have long considered them among the safest fixed-income investments in the world. The federal government sells Treasury securities through pub-lic auctions to finance the federal deficit. When the deficit is large, more bonds come to auction. In addition, the Federal Reserve System (the Fed) uses Treasury securities to implement monetary policy. Technically, Treasury securities issued with 1 to 10 years until maturity are Treasury notes. Securities issued with 10 to 30 years until maturity are Treasury bonds. Figure 7.1 shows that the number of new Treasuries being offered actually declined in the late 1990s as the federal budget deficit declined. However, this reversed in 2002 and then dramatically accelerated in 2009 after the global financial cri-sis and during the years of the FedÕs quantitative easing programs.CORPORATE BONDS Corporations raise capital to finance investments in inven-tory, plant and equipment, research and development, and general business expansion. As managers decide how to raise capital, corporations can issue debt, equity (stocks), or a mixture of both. The driving force behind a corporationÕs financing strategy is the desire to minimize its total capital costs. Through much of the 1990s, corporations tended to issue equity (stocks) to raise capital. Beginning in 1998 and through 2015, corporations switched to raising capital by issuing bonds to take advantage of low interest rates and issued $17.1 trillion in new bonds. You can see this rise in capital reflected in Figure 7.1.05001,0001,5002,0002,50019901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015Annual Bond Issuance ($ Billions)MunicipalTreasuryCorporateFIGURE 7.1 Amount of Capital Raised Yearly from Bonds Issued by Local and Federal Government and CorporationsLocal or municipal governments, the U.S. Treasury, and corporations have issued many new types of bonds and fixed-income securities over the past two decades.Data source: Securities Industry and Financial Markets Association.Final PDF to printer
chapter 7 Valuing Bonds 231cor91411_ch07_226-263.indd 231 01/20/17 06:58 PMMUNICIPAL BONDS State and local governments borrow money to build, repair, or improve streets, highways, hospitals, schools, sewer systems, and so on. The interest and principal on these municipal bonds are repaid in two ways. Projects that benefit the entire community, such as courthouses, schools, and municipal office buildings, are typically funded by general obligation bonds and repaid using tax revenues. Projects that benefit only certain groups of people, such as toll roads and airports, are typically funded by rev-enue bonds and repaid from user fees. Interest payments paid to municipal bondholders are not taxed at the federal level, or by the state for which the bond is issued.Other Bonds and Bond-Based SecuritiesTreasury Inflation-Protected Securities (TIPS) have proved one of the most success-ful recent innovations in the bond market. The U.S. Treasury began issuing this new type of Treasury bond, which is indexed to inflation, in 1997. TIPS have fixed coupon rates like traditional Treasuries. The new aspect is that the federal government adjusts the par value of the TIPS bond for inflation. Specifically, it increases at the rate of infla-tion (measured by the consumer price index, CPI). As the bondÕs par value changes over time, interest payments also change. At maturity, investors receive an inflation-adjusted principal amount. If inflation has been high, investors will expect that the adjusted prin-cipal amount will be substantially higher than the original $1,000. Consider a 10-year TIPS issued on January 15, 2009, that pays a 2⅛ percent coupon. The reference CPI for these bonds is 214.69971. Four years later (on January 15, 2013) the reference CPI was 230.22100. So the par value of the TIPS in early 2013 was $1,072.29 (= $1,000 × 230.22100 Ö 214.69971). Therefore, the 2⅛ percent coupon (paid semiannually) would be $11.39 = (0.02125 × $1,072.29 Ö 2). A TIPSÕ total return comes from both the interest payments and the inflation adjustment to the par value.Treasury Inflation- Protected SecuritiesTIPS are U.S. government bonds where the par value changes with inflation.EXAMPLE 7-2TIPS PaymentsA TIPS bond was issued on July 15, 2006, that pays a 2½ percent coupon. The reference CPI at issue was 201.95. The reference CPI for the following interest payments wereJanuary 2009214.70July 2009213.52January 2010216.25Given these numbers, what is the par value and interest payment of the TIPS on the three interest-payment dates? What is the total return from January 2009 to January 2010?SOLUTION:Compute the TIPS index ratio for each period as current CPI divided by the at-issue CPI: The par value for January 2009 is $1,000 × 214.70 Ö 201.95 = $1,063.13, so the interest pay-ment is 0.025 × $1,063.13 Ö 2 = $13.29. The answers for the next two dates are:July 2009Par value = $1,057.29Interest payment = $13.22January 2010Par value = $1,070.81Interest payment = $13.39The capital gain between January 2009 and January 2010 is $1,070.81 Ð $1,063.13 = $7.68. Adding the two interest payments together results in $26.61 (= $13.22 + $13.39). Thus, the total return is 3.23% = ($7.68 + $26.61 )/$ 1,063.13.Similar to Problems 7-7, 7-8, 7-19, 7-20, 7-33, 7-34LG7-2 For interactive versions of this example, log in to Connect or go to mhhe.com/Cornett4e.Final PDF to printer
232 part four Valuing of Bonds and Stockscor91411_ch07_226-263.indd 232 01/20/17 06:58 PMU.S. government agency securities are debt securities issued to provide low-cost financing for desirable private-sector activities such as home ownership, education, and farming. Fannie Mae, Freddie Mac, Student Loan Marketing Association (Sallie Mae), Federal Farm Credit System, Federal Home Loan Banks, and the Small Business Admin-istration, among others, issue these agency bonds to support particular sectors of the economy. Agency securities do not carry the federal governmentÕs full-faith-and-credit guarantee, but the government has never let one of its agencies fail. Because investors believe that the federal government will continue in this watchdog role, agency bonds are thought to be very safe and may provide a slightly higher return than Treasury securities do.U.S. government agencies invented one popular type of debt security: mortgage-backed securities (MBSs). Fannie Mae and Freddie Mac offer subsidies or mortgage guarantees for people who wouldnÕt otherwise qualify for mortgages, especially first-time homeown-ers. Fannie Mae started out as a government-owned enterprise in 1938 and became a pub-licly held corporation in 1968. Freddie Mac was chartered as a publicly held corporation at its inception in 1970. Since 2008, both have been in government conservatorship and run by the Federal Housing Finance Agency. To increase the amount of money available (liquidity) for the home mortgage market, Fannie Mae and Freddie Mac purchase home mortgages from banks, credit unions, and other lenders. They combine the mortgages into diversified portfolios of such loans and then issue mortgage-backed securities, which represent a share in the mortgage debt, to investors. As homeowners pay off or refinance the underlying portfolio of mortgage loans, MBS investors receive interest and principal payments. After selling mortgages to Fannie Mae or Freddie Mac, mortgage lenders have ÒnewÓ cash to pro-vide more mortgage loans. This process worked well for decades until the late 2000s, when subprime mortgages were given to people who couldnÕt afford them. As you know, defaults on these loans were the underpinnings of the financial crisis.We could apply the same concept to any type of loan; indeed, the financial markets have already invented many such pooled-debt securities. Typical examples include credit card debt, auto loans, home equity loans, and equipment leases. Like mortgage-backed securities, investors receive interest and principal from asset-backed securities as bor-rowers pay off their consumer loans. The asset-backed securities market is one of the fastest-growing areas in the financial services sector.agency bondsBonds issued by U.S. gov-ernment agencies.Treasury bonds are U.S. government-issued debt securities that investors trade on secondary markets. The government also issues nonmarketable debt, called Òsavings bonds,Ó directly to investors. The common EE savings bonds, introduced in 1980, do not pay regular interest payments. Instead, interest accrues and adds to the bondÕs value. After a one-year holding period, they can be redeemed at many banks or credit unions. You can also purchase savings bonds and other Treasury securi-ties (bills, notes, bonds, and TIPS) electronically through the U.S. TreasuryÕs website, treasurydirect.gov. You can set up an account in minutes and buy savings bonds with cash from your bank account. You can also redeem your bonds and transfer the proceeds back to your bank account. Bonds can be pur-chased 24 hours a day, 7 days a week at no cost.When bondholders redeem savings bonds, they receive the original value paid plus the accrued interest. Paper bonds BUY TREASURIES DIRECT!finance at work personal financesell at half of the face value; if investors hold them for the full 30 years, they receive the par value. Investors buy electronic bonds at face value and earn interest in addition to the par value. Unlike other bonds, savers need not report income from these interest payments to the IRS until they actually redeem the bonds. So savings bonds count as tax-deferred investments.About one in six Americans owns savings bonds. Savings bonds are used for a variety of purposes, such as personal savings instruments or gifts from grandparents to grandchil-dren. After the September 11, 2001, terrorist attacks, many Americans wanted to show support for the government. In December 2001, banks selling government EE savings bonds began printing ÒPatriot bondÓ on them. So EE savings bonds are now often called Patriot Bonds.mortgage-backed securitiesSecurities that represent a claim against the cash flows from a pool of mortgage loans.asset-backed securitiesDebt securities whose pay-ments originate from other loans, such as credit card debt, auto loans, and home equity loans.! want to know more?Key Words to Search for Updates: TreasuryDirect (go to www.treasurydirect.gov)Final PDF to printer
chapter 7 Valuing Bonds 233cor91411_ch07_226-263.indd 233 01/20/17 06:58 PMOn the bondÕs maturity date, the bondholder receives the par value, which is typically $1,000. However, some corporate bonds give the bondholder a choice between the par value and a specified number of shares of stock. This type of bond is referred to as a convertible bond because it can be converted to company stock. The number of shares of stock for which the bond can be converted is specified when the bond is originally issued. Thus, the bondholder will want to receive the shares when the stock price has risen since bond issuance, and they will want the $1,000 when the stock has declined in value. Although the bondholder can convert to the stock shares anytime, investors tend to wait until the maturity date when the interest payments from the bond exceed the divi-dends that would be paid from the stock shares. Reading Bond QuotesTo those familiar with bond terminology, bond quotes provide all of the information needed to make informed investment decisions. The volume of Treasury securities traded each day is substantial. Treasury bonds and notes average more than a half billion dollars in trading daily. Investors exhibit much less enthusiasm for corporate or municipal bonds, perhaps because the markets for each particular bond or bonds with the same maturity, coupon rate, and credit ratings are much thinner and, therefore, less liquid. Most bond quote tables report only a small fraction of the outstanding bonds on any given day. Bond quotes and data can be found in The Wall Street Journal and online at places like Yahoo! Finance (finance.yahoo.com). Table 7.2 shows three bond quote examples.convertible bondA debt security that can be converted to shares of stock or another type of security.LG7-3 ! want to know more?Key Words to Search for Updates: subprime, MBS, financial crisisIn the old days, a bank with $100,000 to lend would fund a mortgage and charge a fee for originating the loan. The bank would then collect interest on the loan over time. In the past few decades, the process changed to where that bank could sell that mortgage to investment banks and get the $100,000 back. The bank could then originate another mortgage and collect another fee. Bank revenue transitioned from interest earnings to fee earnings. This worked pretty well for several decades because the bank made more profits and more money was funneled into the community for home buyers. It is the securitization of debt that makes this possible. Finan-cial institutions like Fannie Mae and investment banks bought up these mortgages, pooled them, and issued bonds against them (called mortgage-backed securities, or MBSs) to sell to investors. In effect, buyers of the MBSs are the actual lenders of the mortgage and banks simply earned fees for servicing the loans.Note that this lending model gives banks and mortgage brokers the incentive to initiate as many mortgage loans as they can resell to maximize fee income. Then in 2000 to early 2004, the Federal Reserve kept adjusting interest rates on federal funds downward and kept them low. This both made home ownership more affordable, sparking a housing bubble, and drove investors to look for bonds that paid higher yields. Consequently, many loans were granted to individuals with poor creditworthiness (subprime borrowers). These subprime MORTGAGE-BACKED SECURITIES AND FINANCIAL CRISISfinance at work marketsborrowers were charged higher interest rates. When these subprime mortgages were packed into the pool of mort-gages, the MBSs offered higher yields. Thus, there was a high demand from investors for these MBSs, which fostered more poor credit quality loan originations.Then from July 2004 to July 2006, the Federal Reserve started increasing interest rates. This placed some down-ward pressure on housing prices because it made homes less affordable. At the same time, most subprime mortgages originating from 2005 and 2006 were written on adjustable rates, and those interest rates adjusted upward too, making the payments too high for many borrowers. The subprime bor-rowers soon began to fall behind on their monthly payments leading to foreclosures and additional downward pressure on housing prices. The devaluation of housing prices eroded the home equity of homeowners and led to further foreclosures and further price decreases. The MBSs also devalued quickly.Who owned MBSs? It turns out that the owners of these securities were financial firms, such as investment banks, commercial banks, insurance companies, mutual funds, and pension funds all over the world. Their weakened financial strength led to bank failures, bailouts, and a global credit crisis.Further Reading: John W. Schoen, Ò7 years on from crisis, $150 billion in bank fines and penalties,Ó CNBC, April 30, 2015. http://www.cnbc .com/2015/04/30/7-years-on-from-crisis-150-billion-in-bank-fines-and- penalties.htmlFinal PDF to printer
234 part four Valuing of Bonds and Stockscor91411_ch07_226-263.indd 234 01/20/17 06:58 PMA typical listing for Treasury bonds appears first. Here, this Treasury bond pays bondholders a coupon of 2.750 percent. On a $1,000 par value bond, this interest income would be $27.50 annually, paid as $13.750 every six months per bond. The bond will mature in February of 2018Ñsince this is fairly soon, the bond is considered a short-term bond. Both the bid and the ask quotes for the bond appear, expressed as per-centages of the bondÕs par value of $1,000. The bid price is the price at which investors can sell the bond. A bid of 104.0156 means that an investor could sell for $1,040.156. Investors can buy this bond at the ask price of 104.0313, or $1,040.313. Since the price is higher than the par value of the bond, the bond is selling at a premium to par because its coupon rate is higher than current rates. Thus, investors call this kind of security a premium bond.Notice that the ask price is higher than the bid price. The difference is known as the bid-ask spread. Investors buy at the higher price and sell at the lower price. The bid-ask spread is thus the cost of actively trading bonds. Investors buy and sell with a bond dealer. Since the bond dealer takes the opposite side of the transaction, the dealer buys at the low price and sells at the higher price. The bid-ask spread is part of the dealerÕs compensation for taking on risk. An investor who bought this bond and held it to maturity would experi-ence a $40.31 (= $1,040.31 Ð $1,000) capital loss (Ð3.87 percent [= Ð$40.31/$1,040.31]). The bond lost 0.0234 percent of its value during the dayÕs tradingÑ%
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