www.bondsonline.com - free information on different types of bonds
www.investinginbonds.com - good information on municipal bonds
BONDS (pieces of debt)
Bond yields rise with inflation, and since bond prices always move in the direction opposite that of yields, prices fall as inflation rises.
When buying bonds be on guard against credit risk. Credit risk is the chance that the issuer won't pay interest when it's due (typically semiannually) or won't repay the principal when the bond matures.
Coupon Rate - The rate of interest a bond is obligated to pay each year. A $1,000 bond with a 6% coupon would pay $60 a year, typically $30 semiannually.
Yield To Maturity - The annual rate of return you will receive if you hold a bond for its full term. This figure takes into account the coupon rate, the price you paid for the bond and the principal payment you'll get when the bond matures. Another way of saying this is that yield to maturity takes into account the interest income and price appreciation on a bond. It's the fully compounded rate of return that could be available to you for holding a bond to maturity.
Yield To Call - the annual rate of return you will receive if the issuer calls, or repays, the bond before maturity. Like yield to maturity, this figure factors in the coupon rate, the price you paid and the amount of money you get when the bond is called.
Credit Risk - Also known as default risk, this is the risk that the bond issuer won't make scheduled payments of interest and/of principal.
Interest-Rate Risk - The risk that rising interest rates will drive down the market price of your bond.
Duration - A measure of a bond's sensitivity to fluctuations in interest rates. A bond with a duration of seven years will decline a bit less than 7% if interest rates rise on e percentage point and rise a bit more that 7% if rates drop by the same amount
Current Yield - This is calculated by dividing the market price of a bond into the coupon or stated rate of return. bonds are essentially priced as a percentage of 100. If a bond is priced at 98, it means 98 percent of face value. If a bond has a coupon rate of 8 percent and is priced at 95, the current yield is 8.42 percent. Another way of saying this is that it equals the year's interest payment over current market price.
Bond yields rise with inflation, and since bond prices always move in the direction opposite that of yields, prices fall as inflation rises.
Real Yield - is the difference between the inflation rate and a bond's yield
Laddering Bonds
Laddering bonds is a strategy for purchasing individual bonds with different maturity dates. This investment approach may help minimize the impact of rising interest rates on your portfolio because you regularly have money coming due that can be reinvested at a higher rate.
Laddering may also be a good strategy if you want to have money to meet a specific financial goal at a particular point in time. For example, if you have a child or grandchild who will be starting college in, say, 10 years, you might purchase four zero-coupon municipals that mature in each of the years the child is expected to attend college. In doing so, the proceeds from the maturing securities would coincide with the payments for each year tuition is due.
Laddering doesn't guarantee a profit if you sell your bonds before they reach maturity, since the sale or redemption of any fixed-income security before maturity may result in a substantial gain or loss. Bonds and other fixed-income investments are interest-rate-sensitive, any increase in rates will generally cause your bonds to decline in value. Other factors, such as supply and demand, can also affect the value of your bonds. To help ensure your laddering strategy pans out, plan on holding your bonds until they mature.
Short-term bond = less than 3 years
Intermediate-term bond = 3 to 10 years
Long-term bond = more than 10 years
A general rule in fixed-income investing holds that the longer a bond's maturity, the higher its interest rate. At first glance, deciding which maturity seems easy-invest in the longest-term bonds available, and you get to lock in the highest level of income for an extended period of time. But the rest of the story is that the longer the maturity, the greater the risk. The higher yields of long-term bonds compensate investors for the following two closely related risks: (1) Inflation risk: When a bond is issued, it typically has an interest rate that is higher than the current inflation rate. But what if inflation rises dramatically? You may find that your bond will not provide enough income to keep pace with inflation. And the longer you're locked into a specific interest rate, the more vulnerable you are to rising inflation. (2) Market (or interest-rate) risk: During the life of a bond, its price will rise and fall in response to changing interest rates. Interest rate movements are often driven by change to inflation or inflation expectations. As noted before, since inflation impacts longer-term bonds the most, they tend to experience the widest price swings as interest rates change. So your decision comes down to a balance between how much income you need and how much price volatility you can handle. In other words, determining which bond maturity is right for you depends on your financial goals and risk tolerance.
Short-term bonds can be useful if you are risk-averse or will need to use your principal in the near future. Long-term bonds may be the right choice if you require a high level of income or have a long investment horizon. Just make sure you can tolerate the greater price fluctuation. Intermediate-term bonds occupy the middle ground. they typically offer about 90% of the yield of long-term bonds, but with 75% of the price volatility.
When interest rates rise, bond prices fall; and when rates fall, prices rise. Here's why: suppose you have a bond with a 6% interest rate, and interest rates rise to 7%. Your bond's lower interest rate makes it less desirable, so it loses some of its value in the open market. If you wanted to sell your bond, you'd have to discount the price to attract buyers. Now suppose rates fall to 5%. Your 6% bond is attractive to other investors, so its value in the market increases. You can command a higher price and still attract interested buyers.
Estimating a Bond's Price Volatility - Duration is a time-weighted average of the interest and principal payments from a bond. In the calculation, earlier payments are valued more than later payments (because you can reinvest the money). For example, a 30-year bond with a 6% interest rate has a duration of approximately 11 years.
You can use duration to estimate the price volatility of a bond or bond fund. If you replace the years with a percent sign, it approximates how much a bond's price will fluctuate if interest rates change by one percentage point. Let's go back to the example of a 30-year bond with a duration of 11 years. If interest rates rise from 6% to 7%, the price of the bond would be expected to fall by about 11%. Conversely, if rates fall from 6% to 5%, the bond's price should increase by 11%.
What is the YIELD CURVE??? The yield curve is a chart that tracks the different maturity dates of bonds. The way that the yield curve is trending can sometimes tell you in which way the economy is tracking. If the yield curve chart is trending upward, this usually means that the economy will be good in the future. If the yield curve is trending downward, the economy may be in for a period of slow economic growth. If the yield curse line is flat, your guess is probably as good as anybodies as to which way the economy is heading.
Bonds - Yield Curve
Lower interest rates encourage borrowing by both consumers and businesses and this, in turn, boosts the economy
Higher interest rates discourage borrowing and inhibit economic growth
When economic growth is too strong - which could lead to higher inflation - the Fed raises rates to cool them off. When the economy is slowing down or in a recession, the Fed lowers rates to stimulate spending on the economy.
Return to Investment Planning
Home