Bond Investing – The Basics

Bond investing is not rocket science, but it does require some thought. You can’t race into bond investing the way people race into lesser commitments, like, say, marriage. Bond investing, like anything else, is all about risk and return. Bond investing sits at the low-risk, steady return end of the spectrum, but of course you can stuff it up readily by getting into bond trading instead.

Start by being sure whether you are bond investing or bond trading.

Now, there is not a central exchange for the trading of bonds if you’re not at the stock market. Yet, the procedure is almost as simple as trading stock. You need a brokerage account from a qualified full-service broker or an on-line trading account. It would be necessary to call in or place an order on the Internet. Yet that’s the easy part, it gets slightly more complicated after that.

Besides an interest rate, bonds have a purchase price and sale price. Buying one entitles the bondholder to the payment of principal at maturity – the time when the principal amount must be paid in full, along with twice-annual interest payments.

Risk

As an investment, there is no doubt that bonds too entail risk. Yet bondholders have precedence over shareholders who are the owners of company stock. In case of bankruptcy, if there’s no money to pay, the position in line is unimportant. Yet there is a relatively low risk, as they do repay bondholders the principal.

And while this low risk tends to associate itself with low return, there are several long-standing, esteemed bond rating agencies. The most renowned are Standard and Poor (S&P) and Moody. Both companies rate bonds in accordance with highly analytical formulas and publish their findings.

Price Variations and Interest Rates

Like stocks, bond prices are varied. The opening prices along with the interest rates are set at the same time they are issued. And seconds later, or a few days later, they might just be worth a lot more that the initial price or a lot less than the initial price. The interest rates at the general market prices are a major factors affecting these irregularities. If the interest rate on real estate loans or large corporate bank loans plunge after the bond gets issued, then the price of the bond will usually tend to rise.

So if you buy a 5-year bond for $1,000 which pays 7%, and 6 months later the interest rate falls to 6%, you would now hold a bond which pays more interest than in any other competing investment. You can command a higher price when you do choose to sell. Trading bonds ‘over 100′ is trading at premium, and trading bonds ‘under 100′ is trading at a discount. This terminology refers to value that is 100% under or over the initial price. As an example, a bond sold at a face value of $1,000 that is selling currently for $1,100 is said to be trading at a premium. Actually the irregularities of interest rates are a complex matter based over a large number of market factors.

Bond investing is much more straightforward if you simply buy a bond when it is issued, hold it for its term, and redeem it at maturity. In that case, bond investing is a set-and-forget strategy to get a reliable income stream with a very high probability of also getting your capital back at the end.

Photo: epicharmus

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