Candlestick Trading Blog
November 16, 2007
Bonds in Their Basic Form
A bond in its simplest explanation is a loan provided in the form of a security. In other words, it is a debt security in which the issuer loans the borrower the money, the lender stipulates how much is lent and also what the agreed upon interest rate and term of the loan will be. The incentive (return on investment) for the issuer is that the borrower not only promises to pay back the principal loan amount, but must also pay back any interest accrued throughout the term of the loan. They are typically issued for a fixed-term (known as the maturity), for a time frame of over ten years, and is usually sold in set increments of approximately $1,000. They are also known as fixed income securities because the amount of income produced every year is set when it is sold. They are seen as very attractive to one of many different investment options to both lenders and to borrowers. Listed below are four types of bonds available to the investor. Treasuries – bonds sold by the Corporate Bonds– these will typically carry higher interest rates since corporations carry the risk of going bankrupt, unlike the government who has the power to print more money if needed. They sell debt similar to how they sell stock which is through the public securities markets. They do however have to work to provide competitive interest rates in order to attract investors. When exploring investing options, it is helpful to also know stock market basics and how investing in securities differs from trading stocks. State and Local Government Municipal Bonds – These are interesting because they contain a combination of both characteristics of those listed above. State and local governments do not have the power to print money if needed so in order for them to offer competitive interest rates, they must raise taxes. Since that is such an unpopular method to citizens, the federal government permits them to waive state and local income taxes on them. This works for both the borrower and the issuer because borrowers in high tax brackets typically have a higher after-tax yield and it is more appealing to the borrower. Participating in and understanding the types of securities available to investors leads you toward asset allocation, which in turn help you to build a strong portfolio. Foreign Bonds – These are difficult to buy in that you cannot go directly to the foreign government like you can when purchasing securities through the U.S. Treasury. It is also difficult because they are in limited supply with even the largest firms and a lot of online brokerage firms don’t even sell them. In addition there is usually a commission and/or high mark-up associated with buying these securities. When building your investment portfolio it is important to understand the techniques involved. Portfolio diversification will provide protection of your portfolio through protection of your assets. Listed below are several fundamental investment strategies you can perform to attain the desired results. Laddering – a diversification strategy that involves the purchasing of bonds with various maturities. Investors do this in order to reduce your portfolio’s sensitivity to an interest rate risk. It involves an assortment of securities with maturities distributed over time in order to control your rate of return. Bond swapping – strategy investors use to build a strong portfolio. This is done for multiple reasons some of which are to change maturities, upgrade the credit quality of your portfolio, and/or to increase your current income. Swapping is the simultaneous sale of one security with the purchase of another security. Barbell – this investing strategy involves the investment in securities of more than one maturity in order to limit any risk associated with fluctuating prices. This differs from laddering in that the investor’s goal is to focus on holdings with maturities varying from long to short-term notes set to mature in six months, one year, and 20 to 30 year bonds. Bonds vs. Stocks Stocks and bonds are both securities however the difference is that stock holders (also known as shareholders) actually own a part (shares) of the issuing company, whereas securities holders are seen more as lenders. Bonds are typically purchased by investors since they are considered a low investment risk and are more straight forward in that you can find out how financially stable the issuer is by knowing their rating. Stocks typically do not have a defined maturity either unlike securities who do have set period of time before they can be redeemed. Online Stock Market Reviews presented live via the internet by Stephen Bigalow |
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