The
bond market is a very nice investment. During a market crash a lot of investors
do run to bonds as they become a safe haven from the uncertainty in the
economic downturn. As a return their prices tends to rise in such periods. Bonds are
traditionally money market debt instruments. Debt in the sense that the issuer
of the bond normally issues a bond to raise funds for a project or function. Most bonds are issued at a specified interest rate to the holder of the bond until the end of a specified period(maturity period) after which the principal will be paid.
Bonds
could be issued by government or corporate bodies. Those issued by the federal government and
state are called treasury bonds and municipal bonds respectively. Those issued
by corporate bodies are known as corporate bonds.
The
interest on a bond are known as coupons and are usually quoted annually both
issued semi-annually
The image below shows the typical cash flow from a bond. The bond is bought at a discount a discount of %15 at the price of $8500 a coupon of 400 was paid every six months until the end of the maturity period when the face value of $100,00 is paid plus the $400 for the final half of the year.
The total yield for a bond held till maturity period is given by the mathematical formula.
Where
Face Value = the
price at which a bond will be redeemed at maturity
Years to Maturity = is the number of years
taken for bond to be redeemed.
Price= is the
Current value of the bond in the Market
Common Behaviors, Types of and Nature Bonds You MUST Know
Riskier Bonds
have higher coupon
Bond
issuers tend to increase interest rates to attract investors to their
bonds. They do this to compensate for the higher risk of defaulting payment(being unable to repay the investor his capital). Credit rating
agencies exist because of this, Moody’s, Standard and Poor’s and Fitch being
the big three. AAA is the highest credit rating, while anything lower than a
BBB- is considered a ‘junk’ bond or
“high yield bond”. Other credit rating
agencies rating may choose to rate these companies or investments in terms of
A++, A+ A , A- etc. Kindly note just because a issuer of a bond (company or
country) has A BBB- does not mean that that a company will be unable to pay
back the loan it just means they are not in a good financial situation. Your
ability to weigh risk and returns can help you make a lot of money.
Central Bank's Interest
rates affects the value of the price and yield of a bond
When
the central bank of a nation increases their interest rates, the new bonds which will be
issued and loans generally in the country will tend to be given at a higher interest rate. This makes investors begin to ask themselves why they should hold their bonds with lower interest rates for such a long period when they can get a bond
that pay a higher interest rate within the same period?. The result is that they
begin to sell their bonds to buy ones with higher interest rates. This selling
of existing bonds and buying of newer ones causes the price of existing bonds
to fall and the price of new ones to rise. As a result of this behavior the prices of bonds tend to fall
as interest rates rise of a country rise. They are many banks and investors
that make a lot of money from anticipating this interest changes.
Bonds can be
issued at a discount or premium
Some bonds
are sold at a lower price than their face value(the value the bond will
be repaid), these are called discount bonds. As soon as you buy a discount bond you will have
already received your return upfront For instance buying a bond whose face value(value to be repaid) is $1000 for $900 gives you a 11% return upfront if you hold the bond till maturity. So in a case of a zero coupon bond (bonds
that pays no interest) all you have to do is hold the bond till maturity to
secure your earnings. Note: a bond given at a discount of 10% is gives greater return than another investment offering 10% return. the above example was a bond discounted at 10% but the return was 11%.
Bonds with longer
maturity periods have greater fluctuation in price
Interest
rates, inflation and fiscal policies will be changed more often over a long
period hence bond price will have more fluctuation. Unless you have the ability
to predict interest rate changes and changes of economic policies my advice is
to treat 20 year to 30 year bonds as a retirement investment and hold them to maturity.
Bonds can be
callable or convertible
Bonds
are termed callable when the issuer can repay the principal of a bond to the investor at any given time they
feel interest rates are low enough and cheaper source of funds can be obtained from
somewhere else. The low risk associated with this bonds and their scarcity of
these bonds makes them to be usually charged at a premium (above the face
value.). Convertible bonds on the other hand are bonds that can be converted
into stocks. Hence if you see at any time that the return from stocks is higher
than what you are going to get from the bonds you can sacrifice your annual
coupons to become a share holder of a company.
Bonds also exist
as mutual funds or Exchange Traded funds
Mutual
funds is a collection of funds pooled from various investors and managed by a
fund manager (expert trader) . A Bond Fund is a fund whose portfolio/assets are
exclusively made up of bonds. So many traders prefer this kind of Bond
investment as it diversifies risks. An Exchange Traded Bond Fund is also a
collection of bonds but usually tracks index. Unlike a mutual fund which allows you
own a percentage of the asset, an Exchange Traded Fund(ETF) functions like a
stock market. Thus, you buy and sell ETFs at a certain price. This allows for technical analysis
and returns from change in price.
HOW TO BUY BONDS
Bonds
can be obtained from a Primary market or a secondary market. A primary market
is where the issuer (be it a company or a government) issues it directly to
large investment institutions while the secondary market is where traders
holding the bonds can sell theirs to another investor. The prices here are
rarely going to be at the price the bonds were issued. If you are going to
purchase bonds via a broker you are likely going to be doing so via the
secondary market.
RECOMMENDED BONDS
The
following links gives a list of some of the best bonds one can invest in. I strongly recommend the links as some of the recommendations are renowned all over
the world.
RECOMMENDED
CORPORATE BONDS
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