Page 567 - Introduction to Business

CHAPTER 15 Personal Financial Planning 541

Fixed-Income Investments
A fixed-income investment is one in which you invest an initial amount of money fixed-income investment An investment
(principal), collect interest on that initial amount, and receive back the initial in which an individual invests an initial
amount of money (principal), collects
amount when the security matures. Fixed-income investments are generally low
interest on that initial amount, and
risk, as shown in Exhibit 15.8, but the return on these investments is also typically receives back the initial amount when
rather low. There are two chief dangers associated with fixed-income investments: the security matures
interest rate risk and default risk. Interest rate risk is the risk that interest rates will interest rate risk The risk that interest
rise, resulting in a decrease in the value of the investment. Default risk is the dan- rates will rise, resulting in a decrease in
the value of the investment
ger that the borrower will default either on interest or on principal payments.
The most popular of all fixed-income investments is U.S. Treasury obligations.
Treasury securities are backed by the full faith and credit of the U.S. government
and, therefore, offer the investor both maximum safety of principal and a guaran-
teed yield. The yield is typically less than that of a corporate bond, but Treasury secu-
rities have virtually no default risk. However, they are subject to interest rate risk.

Treasury Securities. The most popular Treasury securities for individual
investors are Treasury bills, Treasury notes, and Treasury bonds. Treasury bills have
maturities up to and including one year. Treasury notes mature in one to ten years,
while Treasury bonds range in maturity from 10 to 30 years.

U.S. Savings Bonds. Savings bonds are another popular fixed-income invest-
ment. Savings bonds are sold at a discount from their face value. They are highly
liquid investments, although if they are cashed in before maturity, there is a reduc-
tion in the rate of interest earned. Interest from Series EE bonds offers the tax
advantage of being exempt from federal income tax until they are cashed in or until
maturity.

Corporate Bonds. Corporate bonds are another form of fixed-income invest-
ment. Compared to government-backed securities, they carry a greater element of
risk. The level of risk depends chiefly on the quality of the corporation issuing the
bonds. Consequently, there is great diversity in risk level.

Municipal Bonds. Municipal bonds are issued by state and local governments
and offer relatively low risk. Also, they feature significant tax advantages, since they
are exempt from federal income tax.

Other Fixed-Income Investments. Other fixed-income investments are
customer accounts provided by banks and savings and loan institutions. From low-
est to highest level of return, the three most popular types of customer accounts are
savings accounts, money market accounts, and certificates of deposit (CDs). Risk is
extremely low and liquidity is high. Consequently, return is relatively low for each
of these types of accounts. Insurance companies issue another kind of fixed-
income investment called an annuity. An annuity is sold by an insurance company
to an investor, who is guaranteed a fixed return for a certain period of time—10
years, 20 years, or the life of the investor.

Equity Investments

Equity investments are investments in corporate stocks. Stocks in companies pub-
licly traded on exchanges such as the New York Stock Exchange and the NASDAQ
are highly liquid. The Wall Street Journal is the best-known source of information

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