5.6 Bonds, Allocation, Diversification

Instructions

OBJECTIVES & STANDARDS
Math Objectives
Compare linear and exponential growth patterns
Apply compound interest formula over various time periods
Calculate percent growth
Common Core Math Standards
Link to all CCSS Math
CCSS.PRACTICE.MP1
CCSS.PRACTICE.MP4
CCSS.HSA.SSE.A.1
CCSS.HSF.IF.B.4
CCSS.HSF.IF.C.7
CCSS.HSF.LE.B.5
Personal Finance Objectives
Define bonds and learn how they produce a return on investment
Explain the inverse relationship between bond yield and interest rates
Learn the importance of diversification and asset allocation for spreading risk
Explain the difference between individual bonds and bond funds
National Standards for Personal Financial Education
Investing
1b: Discuss how a person’s risk tolerance influences their investment decisions
2a Describe the different types of annual cash flows that can be received by investors
2b: Investigate the long-run average rates of returns on small-company stocks, large-company stocks, corporate bonds, and Treasury bonds
5d: Explain why the market price of some assets, such as bonds and real estate, increase when interest rates decrease
6a: Recommend portfolio allocation between major asset classes for a short-term goal versus a long-term goal.
DISTRIBUTION & PLANNING
Distribute to students
Student Activity Packet

ACTIVITY: PLAY: Roll with the Market
Now that you’ve learned how the market works, it’s time to start investing! Follow your teacher’s directions to play this market investing game. Then answer the reflection questions from the game below.

1

Describe the range of emotions you experienced as you played the game.

1

How did your strategy evolve over each round? What factors influenced your strategy?

1

What did you learn about yourself and your tolerance for risk with this game?

1

EDPUZZLE: Bond. Savings Bond.
When investing, it can be good to have something other than just stocks in your portfolio. This is where bonds come in. Watch this video to learn more about how bonds work and why they could be a useful choice to include in your investments. Then, follow your teacher’s directions to answer the questions either within the EdPuzzle itself or on this document.
NOTE: EdPuzzle videos shuffle answer choices and do not always match the order provided in the lesson.

1

INFOGRAPHIC: The Bond See-Saw
Credit risk describes the risk that the borrower defaults and you lose your principal investment. The other risk factor with bonds is the fixed interest rate. Examine the second page of this article addressing interest rate risk and answer the questions.

1

This image is referred to as the “bond see-saw.” What does it show about the relationship between a bond’s price and the overall interest rates of the market?

1

Explain in your own words why that relationship exists.

Imagine you have a bond with ten years left until maturity, a face value of $1000 and a 4% coupon rate. Interest rates recently rose to 6% and you want to figure out how it might impact the price of your bond. We will do some simple calculations, ignoring inflation, to see what might change.

1

How much would this bond pay you back in principal at the end of the 10 years?_______ 

1

How much would you be paid total in interest over the next ten years of holding the bond?_______ 

1

What is the total value of the bond (principal + interest) if you hold it to maturity?_______ 

1

VIDEO: The Power of Diversification
One of the most popular investing strategies is diversification, or the spreading of risk. Watch this short video about diversifying your investments to learn more about how it works. Then, answer the questions.

1

What is meant by “asset allocation?”

1

After allocating assets, what’s the next level of diversifying you should do within asset classes?

ARTICLE: Buying Bonds vs Buying Bond Funds
You know that investing in bonds can be a smart way to diversify your portfolio and reduce overall risk, but what’s the difference between an individual bond and a bond fund? Read this article just through the third section on bond funds, then answer the questions below.

1

How can bond funds help with portfolio diversification more than individual bonds?

1

What is one way investing in a bond fund is like investing in an individual bond?

1

What is one way investing in a bond fund is like investing in the stock market?

9

INTERACTIVE: Exploring Asset Classes
Interactive: Novel Investor's Asset Class Returns
We all know that putting all your investment money into one company’s stock would be pretty risky. But, by choosing an entire asset class instead, would you be minimizing your risk and creating a winning strategy? Let’s find out.

Part I: Define the Asset Classes
An asset class is a grouping of investments that have similar characteristics, behave similarly in the market, and follow the same rules and regulations. Really common asset classes are stocks, bonds, and cash, but there are others as you’ll see below.
Use your prior knowledge, educated guesses, or internet research to match the asset class to its proper description.

Draggable item		Corresponding Item
HY Bnd: High yield bonds		International companies in countries with established industry, widespread infrastructure, and secure economies
Cash: Cash		Bonds with lower credit ratings and a greater chance of default, often issued by startups or struggling businesses
HG Bnd: High grade bonds		Cash or cash equivalents like Treasury bills backed by the federal government
AA: Asset Allocation Portfolio		A diversified portfolio made up of 15% large cap, 15% international, 10% small cap, 10% emerging markets, 10% REITs, 40% high-grade bonds, and annual rebalancing
Lg Cap: Large cap stocks		Largest US companies, which have a market cap over $10 billion
EM: Emerging market stocks		Smaller US companies, which have a market cap between $300 million and $2 billion
REIT: Real estate investment trusts		International companies in countries with still developing capital markets and less stable economies
Sm Cap: Small cap stocks		Bonds with high credit ratings and lower risks of default, usually issued by stable companies
Int’l Stk: International developed stocks		Companies that own, operate, or finance income-generating real estate

In the chart under the interactive, each Asset Class is listed next to an Index. Index funds are what enable you to own many investments in that asset class. For example:

1

What does the “Annual” column of the chart measure?

1

What does it mean when an asset class has “Best” and “Worst” percentages that are spread very far apart?

1

As an investor, you want to buy low and sell high. But, when an asset class has a bad year, such as International Stocks in 2014, why might it be hard to “hold on” without selling?

Part II: Learn to Read the Chart
Interactive
As you hover over a box, such as a dark green one for International Stock, the dark green box for each year will remain highlighted while all other boxes fade to the background. The next few questions will help you learn to read the chart.

1

Which asset class performed better in 2018 -- High Grade Bonds or Small Cap Companies?_______ 

1

What was the annual return for Small Cap Stocks in 2009?_______ 

1

Look at the annual return for Small Cap Stocks in 2010. If the 2010 return is LOWER than it was in 2009, why is Small Cap Stock higher on the list in 2010?

Part III: Dig Deeper on Asset Classes
Now that you’ve got the lay of the land, let’s use this chart to determine whether diversifying into an index fund representing an asset class is enough.

We’ve used the annual returns of each asset class from the chart and the compound interest formula, Value = P(1+i)t , to calculate the expected returns on $1000 of principal invested in each of these different asset class indices over this 15 year period.

1

Let’s look at cash first. It never has a negative year. Does that make Cash Equivalents a good investment? Why or why not?

1

6

1

What are the three common assets considered in asset allocation?
Stocks, bonds, and bond funds
Stocks, bond funds, and mutual funds
Stocks, real estate, and cryptocurrency
Stocks, bonds, and cash

1

The annual interest rate of a bond is called the ______ rate.
Face value
Coupon
Maturity
Discount

1

All of the following are true about diversification EXCEPT...?
Diversification minimizes the risk of one investment failing and ruining your whole portfolio
Diversification ensures that if some investments are going down, others will be going up
Diversification smooths out the volatility of stocks in an investing portfolio
Diversification helps you adjust your investments to fit your changing life needs

5.6 Bonds, Allocation, Diversification

Describe the range of emotions you experienced as you played the game.

How did your strategy evolve over each round? What factors influenced your strategy?

What did you learn about yourself and your tolerance for risk with this game?

This image is referred to as the “bond see-saw.” What does it show about the relationship between a bond’s price and the overall interest rates of the market?

Explain in your own words why that relationship exists.

What is meant by “asset allocation?”

After allocating assets, what’s the next level of diversifying you should do within asset classes?

How can bond funds help with portfolio diversification more than individual bonds?

What is one way investing in a bond fund is like investing in an individual bond?

What is one way investing in a bond fund is like investing in the stock market?

What does the “Annual” column of the chart measure?

What does it mean when an asset class has “Best” and “Worst” percentages that are spread very far apart?

As an investor, you want to buy low and sell high. But, when an asset class has a bad year, such as International Stocks in 2014, why might it be hard to “hold on” without selling?

Look at the annual return for Small Cap Stocks in 2010. If the 2010 return is LOWER than it was in 2009, why is Small Cap Stock higher on the list in 2010?

Let’s look at cash first. It never has a negative year. Does that make Cash Equivalents a good investment? Why or why not?

What are the three common assets considered in asset allocation?Stocks, bonds, and bond fundsStocks, bond funds, and mutual fundsStocks, real estate, and cryptocurrencyStocks, bonds, and cash

The annual interest rate of a bond is called the ______ rate.Face valueCouponMaturityDiscount

Describe the range of emotions you experienced as you played the game.

How did your strategy evolve over each round? What factors influenced your strategy?

What did you learn about yourself and your tolerance for risk with this game?

This game illustrates some of the ups and downs of stock market trends. Depending on how big or little they are, it might make you nervous about putting money into the market. What kind of investment trend might make you feel better about your investment portfolio?

What does the term coupon mean (when related to bonds)?The timeframe of the bondThe annual interest rate paid on a bondThe face value of the bond d. The discounted rate of the bond when purchased

Which is the highest bond rating?AAABBBCCCDDD

Why would someone invest in a bond with a low rating?Lower rated bonds typically have a higher couponLower rated bonds typically have a lower couponLower rated bonds are typically less expensiveLower rated bonds are typically more expensive

What is a bond fund?A bond issued by a corporation to raise funds for a variety of reasonsA bond that does not pay interest but is sold at a discountA mutual fund that invests in a variety of bondsA mutual fund that mimics a particular market index

True or False: Bonds have less risk than stocks, but more risk than a savings account.

This image is referred to as the “bond see-saw.” What does it show about the relationship between a bond’s price and the overall interest rates of the market?

Explain in your own words why that relationship exists.

What is meant by “asset allocation?”

After allocating assets, what’s the next level of diversifying you should do within asset classes?

How can bond funds help with portfolio diversification more than individual bonds?

What is one way investing in a bond fund is like investing in an individual bond?

What is one way investing in a bond fund is like investing in the stock market?

What does the “Annual” column of the chart measure?

What does it mean when an asset class has “Best” and “Worst” percentages that are spread very far apart?

As an investor, you want to buy low and sell high. But, when an asset class has a bad year, such as International Stocks in 2014, why might it be hard to “hold on” without selling?

Look at the annual return for Small Cap Stocks in 2010. If the 2010 return is LOWER than it was in 2009, why is Small Cap Stock higher on the list in 2010?

Let’s look at cash first. It never has a negative year. Does that make Cash Equivalents a good investment? Why or why not?

Do you personally think investing in an asset class is enough to minimize risk and create a winning strategy? Justify your answer.

What are the three common assets considered in asset allocation?Stocks, bonds, and bond fundsStocks, bond funds, and mutual fundsStocks, real estate, and cryptocurrencyStocks, bonds, and cash

The annual interest rate of a bond is called the ______ rate.Face valueCouponMaturityDiscount

This game illustrates some of the ups and downs of stock market trends. Depending on how big or little they are, it might make you nervous about putting money into the market. What kind of investment trend might make you feel better about your investment portfolio?

What does the term coupon mean (when related to bonds)?The timeframe of the bondThe annual interest rate paid on a bondThe face value of the bond d. The discounted rate of the bond when purchased

Which is the highest bond rating?AAABBBCCCDDD

Why would someone invest in a bond with a low rating?Lower rated bonds typically have a higher couponLower rated bonds typically have a lower couponLower rated bonds are typically less expensiveLower rated bonds are typically more expensive

What is a bond fund?A bond issued by a corporation to raise funds for a variety of reasonsA bond that does not pay interest but is sold at a discountA mutual fund that invests in a variety of bondsA mutual fund that mimics a particular market index

True or False: Bonds have less risk than stocks, but more risk than a savings account.

Do you personally think investing in an asset class is enough to minimize risk and create a winning strategy? Justify your answer.

What are the three common assets considered in asset allocation?
Stocks, bonds, and bond funds
Stocks, bond funds, and mutual funds
Stocks, real estate, and cryptocurrency
Stocks, bonds, and cash

The annual interest rate of a bond is called the ______ rate.
Face value
Coupon
Maturity
Discount

What does the term coupon mean (when related to bonds)?
The timeframe of the bond
The annual interest rate paid on a bond
The face value of the bond
d. The discounted rate of the bond when purchased

Which is the highest bond rating?
AAA
BBB
CCC
DDD

Why would someone invest in a bond with a low rating?
Lower rated bonds typically have a higher coupon
Lower rated bonds typically have a lower coupon
Lower rated bonds are typically less expensive
Lower rated bonds are typically more expensive

What is a bond fund?
A bond issued by a corporation to raise funds for a variety of reasons
A bond that does not pay interest but is sold at a discount
A mutual fund that invests in a variety of bonds
A mutual fund that mimics a particular market index

What are the three common assets considered in asset allocation?
Stocks, bonds, and bond funds
Stocks, bond funds, and mutual funds
Stocks, real estate, and cryptocurrency
Stocks, bonds, and cash

The annual interest rate of a bond is called the ______ rate.
Face value
Coupon
Maturity
Discount

What does the term coupon mean (when related to bonds)?
The timeframe of the bond
The annual interest rate paid on a bond
The face value of the bond
d. The discounted rate of the bond when purchased

Which is the highest bond rating?
AAA
BBB
CCC
DDD

Why would someone invest in a bond with a low rating?
Lower rated bonds typically have a higher coupon
Lower rated bonds typically have a lower coupon
Lower rated bonds are typically less expensive
Lower rated bonds are typically more expensive

What is a bond fund?
A bond issued by a corporation to raise funds for a variety of reasons
A bond that does not pay interest but is sold at a discount
A mutual fund that invests in a variety of bonds
A mutual fund that mimics a particular market index