Bonds Q Consider the different types of bonds, Disouss mortgage-backed securities and bond funds fe two main ways governments can raise money? ‘+ What are the two main ways established companies can raise money? ‘+ What are the advantages and disadvantages of bonds for companies and investors? Reading: Bonds United States Department of Treasury Building, Washington, DC Read the text and underline the answers to the questions above. Companies finance most of their activities by way of internally generated cash flows. If they need to raise more money to expand their operations they can either issue nev selling market (equity finance) — or borrow money |debt finance}, usually by issuing bonds. Compani generally use an investment bank to issue their bonds, and to find buyers, which are often institutional investors like insurance companies, ‘mutual funds and pension funds, Bondholders get back their original investment (or ‘principal’) on a fixed maturity date, and receive interest payments (the ‘coupon’ at regular intervals (six-monthly or annually) until ther ‘Most bonds have fixed interest ra For investors, bonds are generally safer than stocks or shares, because if an insolvent or bankrupt company sells its assets, bondholders among the c who might get some of their money back. On the other hand, in the medium or long term, shares generally pay a higher return than bonds. For companies, thi advantage of debt financing over equity financing is that bond interest is tax deductible: companii deduct their interest payments from their profits before paying tax, while dividends paid to shareholders come from already-taxed profits. But debt increases a company’s financial risk: bond interest has to be paid, even in a year without any profits to deduct it from, and the principal has to be repaid when the debt matures, whereas companies are not obliged to pay dividends or repay share capital If tax revenue is insufficient, governments also issue honds to raise money, and these are considered to be a risk-free investment. In the US there are Treasury notes (with a maturity of two to ten years) and Treasury bonds (with a maturity of ten to 30 years}, while in Britain government bonds ate k gilt-edged stock or just gilts Bonds are saleable instruments that can be traded on the secondary bond market. Banks and brokerage companies act as market makers, ‘quoting bid and offer prices for bonds with a v small spread or difference between them. The price of bonds varies inversely with interest rates. If interest rates rise, so that ne to pay a higher rate, existing bonds lose value. If interest rates fall, existing bonds paying a higher terest rate than the market rate increase in value. Consequently the yield of a bond - much income it gives - depends on its purchase price as well as its coupon. Bends Unit 16 81Comprehension Are the following statements true or false? 1 2 3 4 5 6 ow Companies reguiarly finance their activities by issuing bonds Bondissuing companies use investment banks to find investors. Bonds are repaid at 100% when they mature, unless the borrower is insolvent. Bondholders get their money back if'@ company goes bankrupt Bond coupons are generally lower than share dividends For profitable companies, there are tax advantages to Issuing stocks or shares rather than bonds. Governments systematically nance public spending by issuing bonds. Abond paying 5% interest would lose in value ifinterest rates fell to 4% Vocabulary 1 82 Find words in the text that mean the following: 1 the money a company receives minus the money it spends during a certain period art ownership of a campany in the form of stocks or shares funds operated by investment companies that invest people's money in various assets funds that invest money that will be paid to people after they retire from work the amount of capital making up a bond or other loan the length of time for which a bond is issued (until itis repaid) the amount of interest that a bond pays tunable to pay debts 9 people or institutions to whom money is owed 10 payments by companies to their shareholders 11 businesses that buy and sell securities 12 the price at which a buyer is prepared to buy a security at a particular time 13 the price at which a selleris prepared to sell a security at a particular time 14. the rate of income an investor receives from a security eVousun ‘Match up the verbs on the left with the nouns on the right to make common, verb-noun combinations found in the text. Some of the verbs and nouns are used more than once. borrow raise | | (arate offinterest interest payments deduct receive | | areturn money | finance repay |_| activities principal | issue sell |_| assets shares | pay bonds tax dividends What other verb-noun combinations can you make with these words? Unit 16 FondsTeresa La Thangue Finance Listening: Bonds and subprime mortgages Listen to Teresa La Thangue of the Financial Services Authority in London talking about how subprime mortgages, which were discussed in Unit 14, affected bonds in the US. Answer the questions. 1. What terms does Teresa La Thangue use to describe totally safe government bonds? 2 Why were mortgage-backed securities traditionally considered to be very sale? 3 How does she explain the term ‘subprime’? 4 What happened to mortgage-backed bonds in the US? 5 What did the credit rating agencies do wrong? 6 What has been the consequence af this? Discussion + How easy is it to get a mortgage in your country? + Do banks tend to lend to people who might not be able to repay? + Did the banks in your country buy American subprime bonds? If so, why? Reading: How to profit from bonds Read the three extracts from newspaper articles on the next page, and answer these questions. 1. What are the three classes of bonds mentioned? 2 What, according to the journalists and the experts quoted, is happening that makes each type of bond a good investment opportunity? 3. Whyis the government buying back billions of pounds worth of bonds? 4 What kind of companies issue high-yield bonds? 5. What is the risk involved with buying high-yield bonds, and how can it be reduced? Vocabulary Find words in the articles that mean the following: 1 rose quickly 2 torevive or stimulate something 3 a standard used when comparing other things 4 a period when the economy is contracting (three different words) 5 an improvement or increase in prices 6 failing to repay a loan 7 another ward for going bankrupt at's RENAME IT. IME Lascee’ Fyn’ fw MARKET IT fe Weaile dite Law Selb" Steen. Discussion + What has happened to bond prices since the predictions on page 84 were made during the recession in 2008/9? Were the journalists and experts correct? nds Unit16 83Rush to buy government bonds UK government bonds soared for a second day yesterday after the Bank of England unveiled plans to buy billions of pounds of assets to kickstart the economy. Fund managers and speculators rushed 10 buy government bonds, known as gilts, driving up prices. Benchmark 1o-year gilt prices saw their biggest one-day jump in 17 years yesterday. ‘The central bank will create new money tobuy £7 sbn of assets, mainl gilts, at a series of auctions over the next three months. Another £75bn could follow. Many economists believe the unprecedented measures should be enough eventually to lift the economy out of its worst slump since the 1930s. John Wraith of RBC Capital Markets expects the rally in the gilt market to continue for some time. ‘A lot of people will now want to own gilts on the assumption that prices will keep on rising,” he said. ‘The Guardian Case study: Investing in funds Corporate bonds: the only ‘hot’ story in town Good news is thin on the ground for investors. Only brave hearts would look at getting back into the stock market at the moment, as itis still unclear whether we are headed for a worldwide recession or depression. So any area of investment that promises growth is going to spark more than a little interest. And it the unglamorous world of corporate bonds that is catching the attention of those in the know. These bonds, it seems, are the one potentially ‘hot’ investment of 2009. “They represent the opportunity of a generation, offering both capital growth and relatively high income,’ says Meera Patel, senior analyst at independent financial adviser Hargreaves Lansdown, With the world economy speeding downwards, companies that were once thought ultra-safe are now being forced to offer higher returns to investors. ‘The Independent Why high-yield bonds are only for the brave _ For UK investors, opportunities are currently on offer within high-yield bonds. Having been generally overlooked by most investors over the past decade, this asset class has started to grow in popularity, partly due to the staggeringly high yields they have offered since the world phumged into recession last year, Patrick McCullagh, head of European and UK credit research at Schroders, expects high-yield bonds to be offering more attractive opportunities than the investment-grade corporate bonds that are currently in favour. High-yield bonds are investments in the debt of companies that are deemed — by a ratings agency such as Standard & Poor's - to have a greater chance of defaulting on their loans, The lower a company’s rating, the more likely they are to go bust, but the more investors will be paid for accepting that increased risk. Tt means that fund managers who choose wisely can make decent money from this area ‘The Independent In pairs or small groups, look at the advertisements opposite for different bond funds offered for sale by banks. Imagine that you have $30,000 or €30,000 or £20,000 (etc.) to invest in bonds. + Which fund or funds would you choose? Why? + What might be the risks associated with each fund? Writing Write a short report (100-150 words) explaining and justifying your choices. This could begin: We decided to invest in 84 Unit 16 Bonds becauseBi renewable energy fund ‘This fund invests in small firms that lead the global ‘market in manufacturing equipment for generating ‘wind power, building wind farms and producing solar energy systems, Energy is now being produced at competitive prices from wind and solar sources at suitable locations, offering customers an attractively priced, reliable and environment- friendly supply. Investors have an opportunity to benefit from the industry's high rate of growth by investing in its leading players. High-yield Us fund Emerging markets fund This fund aims to achieve « high and steady income and an above average yield, whilst taking into account the security of capital. The fund invests in debt securities in various currencies isued by governments, institutions and companies in emerging markets in four continents. Emerging markets today account for one third of economic activity worldwide and three-quarters of tlobal growth, They are additionally profiting from their Strong competitive position as production locations. This fund aims to achieve a high evel of income, although considerable fluctuations in price cannot be ruled out. The fund invests at Luxury goods fund This fund invests in companies that produce high-priced prestigious branded luxury goods that enjoy stable demand even during tough times for the overall economy. Economic growth in emerging markets is leading to greater | purchasing power and opening up significant | new sales markets for luxury goods firms. a Global microfinance fund least two-thirds of its assets in US-denomineted now-investment grade bonds isued by US companies. Bi Ethical growth fund This fund aims to achieve the highest possible capital growth while investing only in ethically or socially responsible companies. The fund invests in companies whose products and services generate longterm economic, ecological and social benefits. It avoids companies with interests in armaments, tobacco, alcoholic beverages, gambiing, pomography, non-medical animal testing, intensive farming, and nuclear energy. ‘This fund invests in all segments of the elobal microfinance markets. Loans are administered by established ssicrofinance instittions om three continents. The fund aims at long-term growth in valve that is higher than the fund currency’smoney market vale, Microfinance clients operate in an environment that isargely separate from developments in the global markets. They consequently offer excellent possibilities for diversification. a Dynamic international fund This fund aims to achieve high and steady long-term earnings by investing in Eurobonds across the entire range of borrowerratingsand maturities. Investments are made globally with no restrictions as to country, currency or sector. Sizeable short- term price fluctuations are possible. Bi Protection tuna This fund aims to achieve a steady inflation-protected return in euros. The fund invests its net assets worldwide, in accordance with the principle of risk-spreading, in medium to high quality inflation- linked debt securities. Bonds Unit 16 85