Risk Factors Associated With Bond Investing
Keywords: bonds
If you are new to investing perhaps you are not familiar with bonds. Before you get started, you need to understand some of the risks associated with bond investing. Most people assume that all interest-bearing securities are completely risk free, but this is not the case. Even if you know a lot about investing, you may not be aware of some of the risk characteristics associated with bonds.
The most important thing to take into account is the interest rate. The Federal Reserve (also known as the Fed) meets every 6-8 weeks to evaluate the health of the economy. At each meeting, the Fed renders a decision regarding interest rates.
If inflation is rising, the Fed will need to raise interest rates to tighten the money supply. If inflation is moderate or contained, the Fed will likely leave rates unchanged. However, if the economy is slowing down and there is very little inflation or maybe even deflation, then the Fed might decide to reduce interest rates to create a stimulus for economic growth.
The reason why you need to consider present and future interest rate levels is because as interest rates increase, bond prices go down, and vice versa. If you are able to hold your bond until maturity, then interest rate movements do not really matter, because you will redeem the principal upon redemption. But often, investors have to cash out their bonds well before the maturity date. If interest rates have moved up since you purchased the bond, and you sell it prior to maturity, then the bond will be worth less than your initial investment.
You should also be aware of the claim status of the bond you are buying. Claim status refers to your ability to liquidate your investment in the event the bond issuer goes bankrupt. If you are buying a government bond, such as a Treasury Bill, claim status is irrelevant, because the odds of the Federal Government going bankrupt are slim and none.
If you are buying a corporate bond, however, there is always a chance that the issuer could go out of business. In the event of liquidation, bondholders are given priority over stockholders. However, there are often different classes of bondholders. Senior note holders can often claim against certain kinds of physical collateral in the event of bankruptcy, such as equipment (computers, machines, etc.). Regular bondholders can not always claim against physically collateral, and are next in line after the senior note holders.
Next, you should always check the three main features of the bond you are buying; the coupon rate, the maturity date, and the call provisions. The coupon rate is the interest rate. Most bonds pay an interest rate semiannually or annually.
The maturity date is the date that the bond will be redeemed by the issuer; simply put, the maturity date is when the company must pay back to you the principal you loaned to them. The call provisions are the rights of the issuer to buy back your bond prior to maturity. Some bonds are non-callable, while others are callable, meaning that the company can buy your bond back before maturity, usually at a higher price than what you paid.
Finally, you should also understand that if economic conditions become more favorable after you a buy a bond, and interest rates start to go down again, the issuer will likely issue a lot more bonds to take advantage of the low interest rates, and will use the proceeds to try to buy back any callable bonds it issued previously. So, when interest rates go down, there is an increasing likelihood that your bond will be redeemed prior to maturity, if in fact the bond is callable.
You should invest in bonds. However, you should also take into account the risk factors we have covered. Your portfolio should contain a mix of corporate, federal, municipal, and even junk bonds (there is always a default risk associated with junk bonds, but they pay a huge interest rate). Talk to your broker about diversifying the kinds of bonds in your portfolio and you will reduce your overall risk and maximize your return.
Jim Pretin is the owner of www.forms4free.com, a service that helps programmers make an HTML form
Previous Articles Highlighter:
The Truth About Bonds (1)
Some bonds are non-callable, while others are callable, meaning that the company can buy your bond back before maturity, usually at a higher price than what you paid. Finally, you should also understand that if economic conditions become more favorable after you a buy a bond, and interest rates start to go down again, the issuer will likely issue a lot more bonds to take advantage of the low interest rates, and will use the proceeds to try to buy back any callable bonds it issued previously.
Penny Stocks Can Be Lucrative (2)
3) Consumer Demand: Will there be a demand for what the company is selling? Sometimes a company has a great new invention or an exciting technology, but if it is not something practical that consumers are going to want or need, then it does not matter how great it is.
How You Can Avoid Market Timing (3)
Hypothetically, during month one, the price of IBM may be $105 per share, and then it might drop to $95 per share during month two, and then rise to $100 during month three.
Learn To Avoid Market Timing (4)
However, neither of these stragies are necessarily full-proof. Make sure you know something about the company you are going to invest in before deciding which strategy will best help you to avoid the pitfalls of market timing.
Why I Like Penny Stocks (5)
Also, it is easier to get transferred from the Pink Sheets to one of the larger exchanges than it is to go from being a private company to hopping directly on to one of the major exchanges, such as the NASDAQ or NYSE.
Why You Should Invest In Penny Stocks (6)
Simply do a search on Google and read every article ever written about the company, and you will likely find out about their float. This is important because you do not want to invest in a company that already has something like 500 million shares in its float.
How To Select Mutual Funds (7)
Investors might be unaware of the 12b-1 fee because it is sometimes deducted from the share price, so in a way, it is an invisible fee. I hope this introduction to mutual funds will help you make some decisions regarding your investments.
What Is Breakup Value? (8)
Another situation that may arise is if one of the subsidiaries within the corporation has liquidity problems and can not be salvaged, the entire company is affected. As a result, the corporation may have to sell several of their businesses in order to restore the bottom line.
The FOREX Market Is A Goldmine (9)
If there is a significant economic or political development with a certain country, the currency of that country can lose value quickly. There is a higher degree of liquidity on the currency exchange then there is on the stock exchange because the currency exchange is open 24 hours per day and because the very nature of currency exchange is to bet on when certain currencies will go up or down; so, it is easy to sell your position in a certain currency even when the value of that money is going down.
Stock Market Basics (10)
Companies pay out a percentage of their earnings to shareholders in the form of a dividend. There are two different types of stock: common stock and preferred stock. Common stock represents ownership in a corporation.
Introduction To The Forex Market (11)
Also, unlike the stock market, the foreign exchange market is open 24 hours per day, because it is a global market. A trader in Hong Kong may be exchanging currency with a trader in Australia while an American trader is sleeping.
Is Your Stockbroker A Crook? (12)
A smart financial professional has to evaluate research reports and economic data after the market closes each day to decide what needs to be bought or sold within your portfolio.
Understanding Your Insurance Policy (13)
The basic principle of indemnity is that the insurance company will not pay you any more than the amount of the loss suffered. If your house burns to the ground, and you were covered for $500,000 for the dwelling, the company is not going to pay you $1,000,000 so you can go get a bigger house.
What Mergers Mean For Your Investments (14)
Knowing how a merger will affect your investment in a certain stock requires that you first understand the circumstances and the conditions of the buyout. You should ask yourself three important questions: 1) What is the current financial condition of each company?
Introduction To Day Trading (15)
Some look for swings in prices that may last a few seconds or a few minutes. Such a trader literally will buy a stock and then sell it within a few minutes, or sometimes within 30 seconds or less.
Introduction To Mutual Funds (16)
The earlier you begin, the more money you can potentially make down the road. Carefully examine the fee structure and investment strategy before investing and you should do fine.
Tax Consequences Of Municipal Bonds (17)
Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.
P/E Or PEG, Which Is Better? (18)
So, a high P/E ratio can be a very good thing or a very bad thing. As with a high P/E, a low P/E can also be tricky. If it is low, this could be an indication that the earnings of the company are expected to plummet, causing investors to run away from the stock, resulting in a low share price.
Common Investment Scams (19)
Promises of huge returns from offshore investments are usually totally bogus. Another scam you need to be wary of involves prime banks. Prime banks are the top 50 banks in the world.
Understanding Auto Insurance (20)
Comprehensive and collision coverage is normally subject to a deductible, which you should see listed on your policy. The final two coverages listed on your auto policy are rental reimbursement and towing.
Newer Articles Highlighter:
Strategies For Investing In Mutual Funds (1)
If you want a mix of investments, then you should look for a balanced fund. If you want explosive capital appreciation, then you should consider a high-risk common stock or high-yielding bond fund.
How I Reduce My Investment Risk (2)
With the method, investors contribute to their portfolios in such a way that the portfolio balance increases by a set amount, regardless of market fluctuations. As a result, in periods of market declines, the investor contributes more money, while in periods of market climbs, the investor contributes less.
Introduction To Foreign Currency Trading (3)
The other two types of foreign exchange markets are the forward and futures markets. In the forward market, the buyer and seller agree on an exchange rate and a transaction date is set for a specific time in the future, at which point the trade is executed regardless of what the rates are at that time.
Bonds Can Be As Risky As Stocks (4)
But often, investors have to cash out their bonds well before the maturity date. If interest rates have moved up since you purchased the bond, and you sell it prior to maturity, then the bond will be worth less than your initial investment.
What Is The Purpose Of Umbrella Insurance? (5)
Even though multi-million dollar lawsuits are not common, they can happen. So, an umbrella is probably worth it. Jim Pretin is the owner of www.forms4free.com, a service that helps programmers make an HTML form
Is Bond Investing Totally Safe? (6)
Finally, you should also understand that if economic conditions become more favorable after you a buy a bond, and interest rates start to go down again, the issuer will likely issue a lot more bonds to take advantage of the low interest rates, and will use the proceeds to try to buy back any callable bonds it issued previously.
What You Need To Know About Day Trading (7)
This can be especially frustrating for neophyte day traders who have opened up their first brokerage account and then put all of their money into one stock, and then sell it the same day when it goes up, only to discover that they have to wait until the transaction is settled in 3 business days before they can place another order.
Mutual Funds Make It Easy To Diversify (8)
A back-end load, also known as a deferred sales charge, is assessed on your money when you close the account. Back-end charges vary depending upon how long you have had the account.
Can You Lose Money Investing In Bonds? (9)
Your portfolio should contain a mix of corporate, federal, municipal, and even junk bonds (there is always a default risk associated with junk bonds, but they pay a huge interest rate).
Internet Investment Scams (10)
With pump and dump short selling, the borrower instantly sells the stock that was loaned to him and then goes around spreading bad rumors about the company to drive the stock price down so he or she can buy it back at a low price before returning it to the lender.
Is The PEG Ratio Better Than The P/E (11)
The pitfalls of using the P/E ratio to interpret the relative worth of a stock resulted in analysts coming up with a better measurement, which is known as the PEG ratio.
Bonds Are Equally Risky As Stocks (12)
You should also be aware of the claim status of the bond you are buying. Claim status refers to your ability to liquidate your investment in the event the bond issuer goes bankrupt.
Strategies For Combatting Market Timing (13)
If I bought all 1,200 shares during month one, I would have cost me $105 per share. But, by spreading the purchase over a three month period, I managed to buy IBM at an average price of $100 per share.
Managing Your Portfolio Yourself (14)
They rarely even look at their portfolio to see what it contains, and they review their account statements only once per year, because their goal is for their account to grow in the long run.
Why Should You Use The PEG Ratio? (15)
So, you should not necessarily run away from a company with a high P/E. In fact, those companies are sometimes the best investments, because if their earnings climb tremendously, then the stock will pay a large dividend in the future (for the uninitiated, dividends are a percentage of the profits of a company that are distributed to its shareholders).
What You Might Not Know About Bonds (16)
Talk to your broker about diversifying the kinds of bonds in your portfolio and you will reduce your overall risk and maximize your return. Jim Pretin is the owner of www.forms4free.com, a service that helps programmers make an HTML form
Investment Strategies For The Risk Averse (17)
Dollar value averaging usually works better than cost averaging because value averaging results in less money being invested as the stock price goes up, whereas with cost averaging you continue to invest the same number of dollars regardless of the share price.
Commodity Trading - Commodities In Your Portfolio (18)
For one thing, indexes don't tell the whole story. General trends don't show the detailed, day-to-day price movements many traders take advantage of in order to make profits. At the end of today, regardless, what matters is the difference you garnered between what you bought and sold, not the actual prices themselves.
If Real Estate Licenses Came With Marketing Degrees (19)
They did not get into real estate on their way to a lucrative marketing career. In fact many agents don't know anything about marketing and so they just do things as they have always been done.
Dental Insurance - Look Upon It As An Investment (20)
A regular intake of calcium can help increase the strength of the teeth. Staying away from sugary foods and drinks (like soda) and foods that have a high acidity (certain fruits) is also important.