Risk in Bonds Investing

A bond is generally an investment that is low-risk and not as volatile as common stocks are. However, this doesn’t mean that a person can’t go wrong with bonds, because there are also some bond risks, though thankfully small. These risks are called defaulting and changing interest rates.

To understand defaulting, we must understand what buying corporate bonds entails. Fundamentally, purchasing corporate bonds is also buying a claim to the company’s assets. Corporations sometimes take on debt in the hope of developing, and debt is always a risky endeavor. Sometimes, corporations incur too much debt and perform poorly, rendering them incapable of repaying the debt. If worse comes to worst, companies may fire for bankruptcy and won’t even be able to pay the principal amount of their debt. Thus, a bond investor may theoretically lose his/her entire investment.

The other risk, changing interest rates, work like this. When a person invests in a bond, it is possible to sell it on the market any time. Similar to stock, a bond has a specific price assigned by the market. Investors may end up selling their bonds to an open market, and has to acknowledge that people will no only care about the interest rate the bond is paying, but also the interest rate the market currently has. For example, an investor with a bond that pays 7% interest wants to sell the bond in the open market one year later, then finds out that the interest rate of the market for that year is 8%. This investor will probably get a lower price than what he paid, for it’s unlikely that anyone will buy a 6% bond, when they can get a new 8% bond.

To avoid bond risks, investors must be certain to read up on what the current bond rating is– letter grades assigned to each bond that lets investors know how high the risk is. Junk bonds are generally high-risk bonds, so a cautious investor should stay away from it. Additionally, investors shouldn’t purchase bonds when interest rates are low. Finally, bonds are essentially long-term investments, and investors should stick to them for a long time, especially when the interest rate is reasonable. So it goes without saying that the longer one holds on to his bond, the less likely he’ll lose money from it.

Written by admin on December 14th, 2007 with no comments.
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Classification of Corporate Bonds

Basically, corporate bonds are debts issued by industrial, financial and service companies in order to fund capital investments and operate cash flows. When speaking of total face value of bonds outstanding, it is safe to assume that the corporate bond market is larger than each of the markets for other types of bonds, such as municipal bonds, US treasure bonds, and government agency bonds. Those who invest in corporate bonds are given a wide range of choices when it comes to bond structures, maturity dates, coupon rates, industry exposure and credit quality.

There are different types of corporate bonds– these include high yield bonds, and fixed rate capital securities. High yield bonds are bonds issued by organizations which don’t qualify for investment grade ratings, as determined by leading credit rating agencies (agencies who evaluate issuers and assign ratings). As such, these issuers have a greater risk by default, and are rated below investment grade. As such, these issuers are required to pay a higher interest rate so as to attract investors into buying their bonds, and compensate for the higher risks.

Fixed rate capital securities rank senior to common and preferred shares in the issuer’s capital structure, and they have a stated maturity date. Similar to preferred stock, fixed-rate capital securities in general have a $25 liquidation value, has a trade on major securities exchange and are priced at a flat rate including accrued income. However, it is different from preferred stock in the sense that they offer no tax benefits, and carry more risks. Still, fixed rate capital securities are generally attractive in terms of yields and investment grade credit ratings, which makes them a solid choice of investors expecting to achieve enhanced returns without sacrificing credit quality. Additionally, they are suitable for both individual and institutional investors.

Written by admin on December 10th, 2007 with no comments.
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