Page 461 - Encyclopedia of Business and Finance

eobf_I 7/5/06 3:04 PM Page 438

Investments

require. But, of course, times have changed; many Amer- long-term goal, and a place to “park” money while an
icans do invest. They realize that their long-term financial investor seeks more profitable investments.
security does not look promising if it is based only on
Social Security and company-provided pension plans.
CORPORATE BONDS
Both the numbers of people investing and the types of A bond is a form of debt issued by a corporation in
investments available have increased, especially since the exchange for a sum of money lent by the buyer of the
early 1980s. The possibilities for investing funds are far
bond. The issuer of the bond promises to pay a specific
more extensive than just stocks or bonds. In this entry, ten amount of interest at stated intervals for a specific period.
of the most popular investment instruments, from A At the end of the repayment period (on the maturity
(annuities) to Z (zero coupon bonds), will be discussed.
date), the issuer repays the amount of money borrowed.
It is important to understand the differences between
ANNUITIES corporate bondholders and corporate stockholders. The
An annuity provides a means of reducing the risk of out- holder of a corporate bond is a creditor of the corporation
living one’s investment income after retirement from full- that issues the bond, not a part owner, as is a stockholder.
time employment. Purchasing an annuity may be a Therefore, if the corporation’s profits increase during the
possible solution to reducing this risk. An annuity may be term of the bond, bondholders receive no benefit since the
considered the opposite of a traditional life insurance pol- amount of interest they receive is fixed at the time the
icy. An individual who buys insurance agrees to pay bond is purchased. On the other hand, the bondholders’
annual premiums to an insurance company. In return, the investments are safer than those of the stockholders. Inter-
company will pay, according to instructions agreed upon est on bonds is paid out before dividends are distributed
at the time of purchase, the face value of the policy in a to stockholders. Furthermore, the claims of bondholders
lump sum to beneficiaries when the purchaser dies. take precedence over those of the stockholders in the case
By contrast, an individual who buys an annuity pays of bankruptcy or liquidation.
the insurance company a sum of money and, in return, When interest rates rise, bonds lose value; when
will receive a monthly income for as long as the purchaser interest rates fall, bonds become more attractive. Most
lives. Naturally, the longer one lives, the more money is bonds issued today are “callable,” which means corpora-
received. The holder of an annuity never outlives the tions can recall them if interest rates rise before the matu-
return, regardless of how long-lived the individual is. Life rity dates.
insurance protects one’s beneficiaries against financial loss
as a result of the purchaser’s dying too soon, while annu-
GOLD
ities protect purchasers against financial loss as a result of Some investors find gold an appealing investment. Gold
living longer than their funds do.
has been used as money since biblical times. Several char-
Annuity income depends on life expectancy and is
acteristics of gold have made it desirable as a medium of
thus classified as life insurance. Understanding this is exchange and for investment. Gold is scarce. It is durable.
important because the classification allows the annuity’s More than 95 percent of all the gold ever mined during
investment earnings to be treated as tax-deferred, with no
the past 5,000 years is still in circulation. It is inherently
tax on its accumulation until payments are received.
valuable because of its beauty and its usefulness in indus-
trial and decorative applications.
CERTIFICATE OF DEPOSIT Gold has been referred to as the “doomsday metal”
The concept of the certificate of deposit (CD) is simple. because of its traditional role as a bulwark against eco-
It is a savings instrument issued by a financial institution nomic, social, and political upheaval and the resulting loss
that pays the purchaser interest at a guaranteed rate for a of confidence in other investments, even those guaranteed
specific term. When the CD reaches maturity, the investor by national governments.
receives the principal and interest earned. Unlike bond As an investment, gold is not for the faint of heart or
interest (paid periodically), the interest from a CD usually for people who desire a high level of predictability. Its
compounds, which means interest is earned on prior value can fluctuate daily, owing to economic and political
interest earned also. An investment in CDs, up to conditions. When interest rates in the United States fall,
$100,000, is insured by the federal government. the dollar grows weaker in relation to other currencies. As
CDs are appealing for safety, liquidity, and conven- a result, foreign businesspeople find U.S. investment less
ience. Less appealing is the lower yield when compared attractive, and some of them invest in gold instead. This
with other investments. CDs make sense as emergency forces the price of gold higher. When interest rates in the
funds, savings for short-term goals, a way to complete a United States rise, the reverse occurs.

438 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION