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She calmly exits the office. A salesperson and customer are reviewing paperwork. Miss Information walks up to them, and situates herself next to the customer. Salesperson: looking up Excuse me, can I help you? Miss Information: laughing I seriously doubt that, but I can help your customer here!
Customer: Really? Miss Information: Tell me … what are you buying? Customer: Bonds. You like to live your financial life on the edge! Customer: confused Wait … what?! Miss Information: I know a much safer and more lucrative investment than bonds! Here, see for yourself. She hands the customer a brochure. Give me a call about it sometime. The viewing angle shifts to a security camera view. She blows a kiss to a security camera, and exits the building. The security camera feed stops, rewinds, and we watch again as Miss Information blows the camera a kiss, and exits the building.
He gestures to the video screen. We pulled this security footage from an investment broker earlier today. Agent 2: Again, gesturing to the video screen. This is our perpetrator, and she appears to follow the same MO in every case. She contacts the prospective bond buyer, and tells him or her that he or she will lose everything they invest. Agent 1: She goes on to suggest that she knows of safer, more-lucrative investment options, and she leaves behind a pamphlet, and instructs the would-be- -buyers to reconsider their purchase, and to consider investing with her instead.
Commander: A safer and more lucrative investment option than bonds? This has to be the work of Miss Information. He pushes an intercom button. Miss Moneynickel? The director and video crew look perplexed and confused. The director signals to the cameraman to keep rolling. Kris pushes a button on his watch, and a holographic image of the Commander appears. Cameraman zooms into a tight shot of the hologram. Sorry to intrude on you like this but we have a situation and we need your help.
Miss Information is wreaking havoc in the bond market. Kris: Miss Information? Stand by for further instructions. The hologram disappears. A bond is much like a loan. It is a debt instrument, like an IOU. When you buy a bond, you are lending money to a government or corporation. For example, a bond issuer may use your money to fund a project, and, in return, pay you interest. Bond prices move opposite the market interest rate. For example, suppose the yield on other investments rises relative to bonds.
Bond holders may want to sell their bonds to get higher yields elsewhere. To attract buyers, bond prices will come down. This, in effect, increases the yield on bonds. All levels of government issue bonds, and so do corporations. Often, when people use the term bond, they are including other debt instruments as well.
Just remember that debt instruments like U. In fact, corporations issue bonds that may take up to 30 years to mature—when the investor is paid the last interest payment and initial dollar investment. One way in which bonds vary is whether they are coupon or non-coupon bonds. Investors purchase newly issued coupon bonds at a dollar amount called the face or par value. The investor receives interest payments for a set time--—usually semi-annually or annually—until the bond matures.
At the end of the term, the investor receives the initial investment back with the final interest payment, assuming the bond issuer has the funds. Many bondholders use the interest payments as income, for example, in retirement. Zero-coupon bonds, are sold at a price lower than their face value because the buyers receive all of their return or interest when the bond matures.
Bonds, like U. They offer a great opportunity to save for retirement or for college. There are various features of Treasury securities to consider. If inflation rises, the principal of the bond is adjusted upward and vice versa. Is the bond's interest rate a fixed or a floating one? Does the issuer seem able to handle the interest payments? In case of default, where does this bond stand in the pecking order of repaying principal? What Is My Risk Tolerance? The goal is to determine how much risk they can or are willing to take when investing in bonds.
Without knowing how much risk you want to take or avoid, an overall strategy cannot emerge. How Risky is This Bond? There are numerous risks involved with bonds, especially corporate bonds. Some specific types of risk of primary concern are inflation risk, interest rate risk, liquidity risk, and credit risk. Happily, several management tools exist to assess, analyze and ultimately help investors manage these risks. One of the primary ones is the bond rating , a letter grade assigned by an independent credit rating company to the debt that indicates its credit qualit y.
The better the grade, the less likely the chance of the issuer's defaulting on the bond. The maturity date is the date the bond falls due. The investor redeems—that is, receives back—his principal the money they invested in the bond —selling the bond back to the issuer, in a sense. Investors must consider another significant risk factor with a bond: the chance it is called —that is, bought back before its maturity date.
Are the Interest Payments Fixed or Floating? Fixed coupons offer a set percentage of the face value in interest payments. Floating rate bonds, on the other hand, pay a variable coupon rate that is pegged to a particular benchmark rate. Most floating rate bonds are issued with two- to five-year maturities.
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Factor in macroeconomic risks. When interest rates rise, bonds lose value. Interest rate risk is the risk that rates will change before the bond reaches its maturity date. Instead, focus on your long-term investment objectives. Rising inflation also poses risks for bonds. Support your broader investment objectives. Bonds should help diversify your portfolio and counterbalance your investment in stocks and other asset classes. To make sure your portfolio is balanced appropriately, you may want to consult an asset allocation calculator based on age.
Read the prospectus carefully. The name of the fund may only tell part of the story; for example, sometimes government bond funds also include non-government bonds. Use a broker who specializes in bonds. Learn about any fees and commissions. Your broker can help break down the fees associated with your investment. What are the benefits of investing in bonds? Bonds offer a host of advantages: Capital preservation: Capital preservation means protecting the absolute value of your investment via assets that promise return of principal.
Because bonds typically carry less risk than stocks, these assets can be a good choice for investors with less time to recoup losses. Income generation: Bonds provide a fixed amount of income at regular intervals in the form of coupon payments. Diversification: Investing in a balance of stocks, bonds and other asset classes can help you build a portfolio that seeks returns but is resilient through all market environments.
Stocks and bonds typically have an inverse relationship, meaning that when the stock market is down, bonds become more appealing. Risk management: Fixed income is broadly understood to carry lower risk than stocks. This is because fixed income assets are generally less sensitive to macroeconomic risks, such as economic downturns and geopolitical events.
Invest in a community: Municipal bonds allow you to give back to a community. While these bonds may not provide the higher yield of a corporate bond, they often are used to help build a hospital or school or that can improve the standard of living for many people. What are the risks associated with investing in bonds? As with any investment, buying bonds also entails risks: Interest rate risk: When interest rates rise, bond prices fall, and the bonds that you currently hold can lose value.
Interest rate movements are the major cause of price volatility in bond markets. Inflation risk: Inflation is the rate at which the price of goods and services rises over time. If the rate of inflation outpaces the fixed amount of income a bond provides, the investor loses purchasing power. Credit risk: Credit risk also known as business risk or financial risk is the possibility that an issuer could default on its debt obligation.
Liquidity risk: Liquidity risk is the possibility that an investor might wish to sell a bond but is unable to find a buyer. Stocks tend to earn more money than bonds. In the period , stocks averaged a return of Bonds freeze your investment for a fixed period of time.
This creates the potential for your initial investment to lose value. Stocks, on the other hand, can be sold at any time. You can manage these risks by diversifying your investments within your portfolio. Where can I buy bonds? Stocks are traded on a centralized market, meaning that all trades are routed to one exchange and are bought and sold at one price. Instead, bonds are traded over the counter, meaning that you must buy them from brokers. However, you can buy U.
Treasury bonds directly from the government. Happily, several management tools exist to assess, analyze and ultimately help investors manage these risks. One of the primary ones is the bond rating , a letter grade assigned by an independent credit rating company to the debt that indicates its credit qualit y. The better the grade, the less likely the chance of the issuer's defaulting on the bond. The maturity date is the date the bond falls due.
The investor redeems—that is, receives back—his principal the money they invested in the bond —selling the bond back to the issuer, in a sense. Investors must consider another significant risk factor with a bond: the chance it is called —that is, bought back before its maturity date. Are the Interest Payments Fixed or Floating? Fixed coupons offer a set percentage of the face value in interest payments.
Floating rate bonds, on the other hand, pay a variable coupon rate that is pegged to a particular benchmark rate. Most floating rate bonds are issued with two- to five-year maturities. Keep in mind that companies issue bonds as a way to attract loans, so bond purchasers are lending their funds to the issuer. Therefore, just like they would when assessing anyone they offer a loan to, investors should make sure the issuer is prepared to make good on the payments and principal promised at maturity.
Before investing, you should determine whether you are likely to receive your money back or part of your money in the event an issuer goes into default or becomes insolvent. Typically, investors will do this both through the determination of two figures: loss given default LGD and the recovery rate. Additionally, besides knowing whether or not a bond is secured, it is important to know where it ranks in seniority for other secured bonds in terms of payout—should the issuer become insolvent when do they close during insolvency.
The Bottom Line Investing in bonds requires attention both before the actual investment and as long as the bonds are held. Article Sources Investopedia requires writers to use primary sources to support their work.
These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
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