Tuesday 29 May 2012

The beginner's guide to the bond market

By Dr Jonathan Rosental


Recent stock market crashes have forced independent investors to look again at the importance of bonds as another investment option. The most conservative stock market advisors recommend keeping two thirds of all funds in bonds.

A standard bond is usually an obligation to pay semiannual coupons and then full face value when bond maturity comes. Zero-coupon bonds, on the other hand, are discounted but come with no coupons.

Fixed income securities such as bonds do not provide access to company operations that stock holders enjoy. Nevertheless, many independent investors prefer bonds due to their higher reliability.

United States represent one of the largest bond issuers in the world that accumulates debts by selling treasury notes and treasury bonds. Treasury bonds have maturity from 10 to 30 years and treasury notes up to ten years.

US government bonds are considered the most reliable investments in the world because US government always pays off its debts. As a result, when mentioning risk-free interest rate your MBA tutor most likely means T-bill interest rate.

After periods of high inflation induced by the sky-rocketing oil prices US treasure started to offer inflation protected bonds. These instruments typically allow the principal amount to adjust proportionally to increases in consumer price index.

Another difference of the American bond market is a large number of Federal agencies issuing own bonds to finance mortgage and related activities. Buyers of these bonds often believe that Federal government will protect their investments in the worst possible case.

European and Asian countries have quite developed bond markets as well. Sometimes companies such as Chico's FAS common Stock would prefer to borrow in foreign currency.

They can then issue Eurobonds which are any bond issued in a currency different from a domestic currency. For example, an American company can offer dollar-denominated bonds in the United Kingdom that are often traded in London.

Local and state authorities may offer their own municipal bonds to finance specific projects. Municipal bonds are not subject to the federal income tax which makes them quite popular with retirees and public workers.

The picture will be incomplete without corporate bonds that are quite popular with adjunct professor of economics. Corporate bonds are considered to be much more risky than US treasury bonds because corporations typically have higher chances of default.

Secured corporate bonds are typically the safest corporate bonds because they have some underlying collateral. Corporate bonds sometimes come with options that allow corporations to purchase bonds back at a specified call price.




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