Personal Finance Ch. 11

Financial goals should be: Specific, Measurable, Tailored to your financial needs, Aimed at what you want to accomplish
Risk Uncertainty about the outcome
Investment safety Minimal risk of loss
Risk-Return trade-off The potential return on any investment should be directly related to the risk the investor assumes
Speculative Investments Are high risk, made by those seeking a large profit in a short time
Inflation risk during periods of high inflation your investment return may not keep pace with inflation
Interest rate risk the value of bonds or preferred stock may increase or decrease with changes in interest rates
Business failure risk affects stocks and corporate bonds
Market risk the risk of being in the market versus in a risk-free asset
Investment Income A predictable source of income (dividends or interest)Most conservative = passbook savings, CDs and government securities
Investment Growth Growth in value (price appreciation)Common stock usually offers the greatest potential for growthMutual funds and real estate offer growth potential
Investment Liquidity 2 dimensionsAbility to buy or sell an investment quickly Without substantially affecting the investment’s value
Assest Allocation The process of spreading your assets among several different types of investments
Diversification Stocks, Bonds, Risk-free assets, Real-estate
Government bonds equals written pledge to:Repay a specified sum of money (face value) At maturity, Along with periodic interest payments. Sold to fund the national debt and the ongoing costs of government at all levels
Three levels of government bonds Federal, State, Local municipalities
Treasury Bills (T-Bills) $100 minimum4, 13, 26 and 52 weeks to maturitySold at a discountFederal but no state tax on interest earned
Treasury Notes $100 unitsTypical maturities = 2, 3, 5, 7, and 10 yearsInterest paid every six monthsHigher rate than T-billsFederal but no state tax on interest earned
Treasury Bonds Issued in minimum units of $10030 year maturity datesInterest rates higher than notes and billsInterest paid every six months
Treasury Inflation-Protected Securities (TIPS) Sold in minimum units of $100Sold with 5, 10, or 30 year maturitiesPrincipal changes with inflation Pays interest twice a year at a fixed rate
Municipal Bonds (“munis”) Issued by a state or local government, Cities, Counties, School districts, Special taxing districts. Funds used for ongoing costs and to build major projects such as schools, airports, and bridges
General obligation bonds Backed by the full faith, credit, and taxing authority of the issuing state or local government
Revenue bonds Repaid from money generated by the project the funds finance, such as a toll bridge
Insured municipal bonds Private insurance to reduce risk
Corporate Bonds A corporation’s written pledge to repay a specified amount of money with interestAn interest-only loanConsidered safer than stocksA “fixed-income” securityA form of debt financing
Face value Dollar amount bondholder receives at bond’s maturity dateUsually $1,000
Coupon rate Stated interest rateInterest payments made every six months
Maturity date date on which face value repaid
Bond Indenture Legal document describing conditions of the bond issue
Trustee Financially independent firm that acts as the bondholder’s representative. Usually a commercial bank or other financial institution
Debenture Unsecured. Backed only by the reputation of the issuing company
Mortgage bond Secured by various assets of the issuing firm, usually real estate. Lower interest (coupon) rate since debt is secured
Convertible bond Can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock. Generally, the coupon rate on a convertible bond is 1 to 2 percent lower than the rate paid on traditional bonds
Sinking fund Corporations deposit money annuallyTrustee uses the money to retire the bond issue prior to maturity
Serial bonds Bonds of a single issue that mature on different dates
Interest Income “fixed income”
Yield rate of return earned by an investor who holds the bond to maturity

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