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Investing in bonds chapter 13
As the cash flows of the bonds are fixed when it is first issued they will buy less when prices go up in the future. On the other hand, dividends paid to shareholders often go up in line with or by more than inflation if the company paying them can increase the prices for the stuff that it sells. Bond investors are usually compensated for the risk of inflation by being offered a higher interest rate.
The longer the life of the bond, the bigger the inflation risk and typically the higher the required interest rate. Higher inflation is therefore bad news for conventional bonds. Falling inflation or deflation falling prices though can make them more attractive because the cash from interest payments will buy more stuff. Investors in bonds can also try to protect themselves from inflation by buying inflation-protected often referred to as indelinked bonds. With these bonds, the interest payments and the capital value of the bond are adjusted in line with an inflation index such as the retail prices index or RPI.
This allows the investor to maintain the buying power of their money. These bonds tend to be issued by governments but companies such as National Grid and Severn Trent have issued some as well. How bonds work In SharePad and ShareScope you get lots of information about individual government and corporate bonds. In this section, I am going to tell you what all this information means and why it is important.
Alternatively, it is sometimes called its redemption value, maturity value or face amount. This is usually their par value and what investors expect to get back when the bond matures. However, the nearer the bond gets to its maturity date, the closer the price gets to its par value as this is the amount that will be paid back. Maturity date This is when the par value is returned to investors. For Treasury this will be on 7th December The Treasury bond has a coupon rate of 4. Most government bonds pay coupons twice a year.
They are known as zero coupon bonds. The investor gets a return by buying the bond at a discount to its par value less than its par value. The difference between the discounted value and the par value at maturity is the effective interest on the bond. The income yield is simply the coupon interest rate divided by the last closing price of the bond. This is where the gross redemption yield or yield to maturity comes in.
This yield takes into account the income received from coupons and the gain or loss on the par value when buying the bond at its current price over the remaining life of the bond. It gives a total return for an investor buying the bond today and holding it until it matures. For Treasury , the gross redemption yield is 2.
In a very rough and ready way, the gross redemption yield can be thought of as the sum of the income yield plus the capital gain or loss as a percentage of the current price divided by the number of years to maturity. This is how the Japanese version of the gross redemption yield is calculated. So a rough approximation of the gross redemption yield is the income yield of 3. This is less than the quoted gross redemption yield of 2. For those of you who know a little bit about maths, the GRY is calculated using a process known as an internal rate of return IRR which factors in the timing of the coupons and when the par value is repaid.
I am not going to get into the maths here but suggest that you base any decisions on the quoted gross redemption yield. Accrued interest The dividend on a share is paid to the holder on the share register on the ex-dividend date. Bonds work slightly differently.
The seller of the bond is entitled to their share of the interest for the period that they have owned the bond since the last coupon was paid. For the Treasury bond, the accrued interest is Dirty price Bonds have two prices — a clean and a dirty one. The clean price is the quoted price that you see in SharePad. The dirty price is the clean price plus accrued interest.
The relationship between bond prices and interest rates The price of a bond can change for different reasons but by far the biggest reason for any price change is a change in interest rates. Bond prices move in the opposite direction to a move in interest rates. I like to think of this relationship as being similar to a see-saw — when one end is up the other end is down. Put another way: Bond prices rise when interest rates fall. Bond prices fall when interest rates rise.
By understanding this it is possible to have a very simple rule for investing in bonds: Sell if you think interest rates are going up Buy if you think interest rates are going down. But different bonds with different maturities and coupons will behave in a different way to changes in interest rates.
Macaulay duration also known simply as duration essentially tells you how long it will take you to get your money back when you buy a bond. It is based on the weighted average of the cash flows of a bond its coupons and par value until maturity. Duration is influenced by the life of the bond and the size of the coupon. So low-coupon, long-life bonds will have a longer duration than high-coupon, short-life bonds because it takes a longer time for the buyer to get their money back.
Remember, the longer the duration the more sensitive the bond is to a change in interest rates. The Treasury bond has a long Macaulay duration of It has a Modified duration of That is a big price change and is a powerful illustration how lots of money can be made and lost by trading bonds. It gives rise to another simple strategy that is often used by professional investors. Buy long-duration bonds if interest rates are expected to fall.
Sell long-duration bonds if interest rates are expected to rise. If bond fund managers are worried that interest rates will rise they will often try to protect the value of their portfolio by buying more shorter-duration bonds. Yes, the price of the bond will bounce around if interest rates change but unless the issuer of the bond defaults you will still get your coupons and your money back.
Bond laddering avoids some of the risks of locking into a lower interest-paying bond investment if interest rates rise and bond prices fall. It is a possible strategy for people looking for alternatives to annuities when trying to produce an income from their pension pot.
Looking at bonds with SharePad You can use SharePad to filter for bonds just as easily as you can for shares. This might be a strategy used by a more risk-averse bond investor. SharePad has found 39 shares that meet these criteria. You could compare this bond with Tesco shares which currently pay no dividend. If the price is higher than , the bond is trading at a premium. If the price is lower than , the bond is trading at a discount.
A revenue bond is a muni issued to raise money for a public-works project. A general obligation bond is a muni backed by the power of the issuing state or local government to levy taxes and borrow. Municipal bonds are exempt from both federal and state taxes. A zero-coupon bond is a bond that is sold at a deep discount, makes no interest payments and is redeemable for its face value at maturity.
The highest rating is AAA. The lowest rating is D. A D rating indicates the bond is in default. A junk bond is a bond that has a low rating, or no rating at all.
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Bonds can be a safe investment if held to maturity. The rights of bondholders. The rights of the issuing firm. The responsibilities of the bond trustees. The poorer the rating, the higher the rate of return demanded by investors. Safest bonds receive AAA, D is extremely risky. When interest rates rise, the value of outstanding bonds falls.
When interest rates rise, bond values drop, and when interest rates drop, bond values rise. Longer-term bonds fluctuate in price more than shorter-term bonds. When interest rates go down, bond prices go up, but upward price movement on bonds with a call provision is limited by the call price. If you expect interest rates to go down bond prices to rise —purchase bonds with long maturities and are not callable.
Similar to bonds—dividends are fixed, paid before common and no voting rights. As market interest rates rise and fall, the value of preferred stock moves in an opposite manner 36 Risks Associated with Preferred Stock If interest rates rise, the value of preferred stock drops. Instead of going to a bank to borrow money or issuing shares to investors, bonds are sold to investors as a way of raising money. By giving a company or a government some of your money you expect to receive some form of interest like a bank account and get your money back at some date in the future.
As with most investments there is usually a trade off between the risks that you take and the returns that you get back. More risky bonds tend to offer higher rates of interest rates to compensate you for the risk that you might not get your interest paid to you or your money back. Types of bonds As a private investor you can invest in lots of different types of bond but usually there are four main choices: Government bonds.
These are known as gilts in the UK. Company or corporate bonds Inflation-protected index-linked bonds. A bond fund More often than not, the borrowings of governments have been seen as the safest bond investments which has meant that they pay the lowest rates of interest. Companies can and do go bust and so have to pay higher interest rates than governments to borrow money. Here the interest rates on offer tend to be very high. They may seem tempting but the risk of losing all or some of your money if the company goes bust should not be ignored.
The role of bonds in a portfolio Historically bonds have been less risky investments than shares. They can be a good way of spreading your risks in a portfolio and may allow you to sleep easier at night when the stock market has one of its darker periods.
They also tend to be seen as a good way to produce a safer source of income from investing than shares. So why are bonds seen as being less risky investments? The borrowings of companies are less risky than its shares because bondholders get paid before shareholders who are last in the queue to get paid.
The good thing about most bonds is that you have a good idea of what returns you can receive when you buy it. As the interest payments and repayment values are usually known in advance there is much more certainty in owning a bond than owning a share. It is this feature which has made them popular with investors. Unlike the return from shares where future dividends and share prices can be quite difficult to predict, the returns from bonds are more straightforward.
Bonds are not risk free investments Whilst bonds are less risky than shares they are not without risk. It is possible to lose money investing in bonds. Bonds contain three main risks: Not getting your money back Once seen as unthinkable, for governments this is now quite possible. You only have to look at the government bonds of countries such as Greece in recent times where a weak economy means that the government struggles to generate enough income from taxes to pay the interest on its bonds.
Unlike the UK government, Greece and other members of the euro area are not free to print their own money to pay their debts. The same risk of not getting your money back applies to company bonds too. Companies do go bust and leave bondholders high and dry. Paying back the loan at the end of its life can be difficult sometimes as well. Bonds are often repaid by issuing new bonds to raise the cash. But what if no-one wants to lend the company fresh money?
If the company is in good health this is not usually a problem. But if the financial markets are in a state of panic — like in — it may be more difficult. Rising interest rates The prices of bonds usually move in the opposite direction to the changes in interest rates. They will not stay the same as before the increase in rates as people will not want to buy investments with low rates when they can get higher ones — for the same risk — elsewhere.
Rising inflation The whole point of investing is to grow the buying power of your money. Herein is the big problem of buying conventional bonds. As the cash flows of the bonds are fixed when it is first issued they will buy less when prices go up in the future.
On the other hand, dividends paid to shareholders often go up in line with or by more than inflation if the company paying them can increase the prices for the stuff that it sells. Bond investors are usually compensated for the risk of inflation by being offered a higher interest rate. The longer the life of the bond, the bigger the inflation risk and typically the higher the required interest rate.
Higher inflation is therefore bad news for conventional bonds. Falling inflation or deflation falling prices though can make them more attractive because the cash from interest payments will buy more stuff. Investors in bonds can also try to protect themselves from inflation by buying inflation-protected often referred to as indelinked bonds. With these bonds, the interest payments and the capital value of the bond are adjusted in line with an inflation index such as the retail prices index or RPI.
This allows the investor to maintain the buying power of their money. These bonds tend to be issued by governments but companies such as National Grid and Severn Trent have issued some as well. How bonds work In SharePad and ShareScope you get lots of information about individual government and corporate bonds. In this section, I am going to tell you what all this information means and why it is important. Alternatively, it is sometimes called its redemption value, maturity value or face amount.
This is usually their par value and what investors expect to get back when the bond matures. However, the nearer the bond gets to its maturity date, the closer the price gets to its par value as this is the amount that will be paid back. Maturity date This is when the par value is returned to investors. For Treasury this will be on 7th December The Treasury bond has a coupon rate of 4. Most government bonds pay coupons twice a year. They are known as zero coupon bonds.
The investor gets a return by buying the bond at a discount to its par value less than its par value. The difference between the discounted value and the par value at maturity is the effective interest on the bond. The income yield is simply the coupon interest rate divided by the last closing price of the bond.
This is where the gross redemption yield or yield to maturity comes in. This yield takes into account the income received from coupons and the gain or loss on the par value when buying the bond at its current price over the remaining life of the bond.
It gives a total return for an investor buying the bond today and holding it until it matures. For Treasury , the gross redemption yield is 2. In a very rough and ready way, the gross redemption yield can be thought of as the sum of the income yield plus the capital gain or loss as a percentage of the current price divided by the number of years to maturity.
This is how the Japanese version of the gross redemption yield is calculated. So a rough approximation of the gross redemption yield is the income yield of 3.
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The rights of bondholders. The rights of the issuing firm. The responsibilities of the bond trustees. The poorer the rating, the higher the rate of return demanded by investors. Safest bonds receive AAA, D is extremely risky. When interest rates rise, the value of outstanding bonds falls. When interest rates rise, bond values drop, and when interest rates drop, bond values rise. Longer-term bonds fluctuate in price more than shorter-term bonds.
When interest rates go down, bond prices go up, but upward price movement on bonds with a call provision is limited by the call price. If you expect interest rates to go down bond prices to rise —purchase bonds with long maturities and are not callable. Similar to bonds—dividends are fixed, paid before common and no voting rights. As market interest rates rise and fall, the value of preferred stock moves in an opposite manner 36 Risks Associated with Preferred Stock If interest rates rise, the value of preferred stock drops.
If interest rates drop, the value of preferred stock rises and it is called away. However, the nearer the bond gets to its maturity date, the closer the price gets to its par value as this is the amount that will be paid back. Maturity date This is when the par value is returned to investors. For Treasury this will be on 7th December The Treasury bond has a coupon rate of 4. Most government bonds pay coupons twice a year. They are known as zero coupon bonds. The investor gets a return by buying the bond at a discount to its par value less than its par value.
The difference between the discounted value and the par value at maturity is the effective interest on the bond. The income yield is simply the coupon interest rate divided by the last closing price of the bond. This is where the gross redemption yield or yield to maturity comes in. This yield takes into account the income received from coupons and the gain or loss on the par value when buying the bond at its current price over the remaining life of the bond.
It gives a total return for an investor buying the bond today and holding it until it matures. For Treasury , the gross redemption yield is 2. In a very rough and ready way, the gross redemption yield can be thought of as the sum of the income yield plus the capital gain or loss as a percentage of the current price divided by the number of years to maturity. This is how the Japanese version of the gross redemption yield is calculated.
So a rough approximation of the gross redemption yield is the income yield of 3. This is less than the quoted gross redemption yield of 2. For those of you who know a little bit about maths, the GRY is calculated using a process known as an internal rate of return IRR which factors in the timing of the coupons and when the par value is repaid. I am not going to get into the maths here but suggest that you base any decisions on the quoted gross redemption yield.
Accrued interest The dividend on a share is paid to the holder on the share register on the ex-dividend date. Bonds work slightly differently. The seller of the bond is entitled to their share of the interest for the period that they have owned the bond since the last coupon was paid.
For the Treasury bond, the accrued interest is Dirty price Bonds have two prices — a clean and a dirty one. The clean price is the quoted price that you see in SharePad. The dirty price is the clean price plus accrued interest. The relationship between bond prices and interest rates The price of a bond can change for different reasons but by far the biggest reason for any price change is a change in interest rates. Bond prices move in the opposite direction to a move in interest rates.
I like to think of this relationship as being similar to a see-saw — when one end is up the other end is down. Put another way: Bond prices rise when interest rates fall. Bond prices fall when interest rates rise. By understanding this it is possible to have a very simple rule for investing in bonds: Sell if you think interest rates are going up Buy if you think interest rates are going down. But different bonds with different maturities and coupons will behave in a different way to changes in interest rates.
Macaulay duration also known simply as duration essentially tells you how long it will take you to get your money back when you buy a bond. It is based on the weighted average of the cash flows of a bond its coupons and par value until maturity. Duration is influenced by the life of the bond and the size of the coupon. So low-coupon, long-life bonds will have a longer duration than high-coupon, short-life bonds because it takes a longer time for the buyer to get their money back.
Remember, the longer the duration the more sensitive the bond is to a change in interest rates. The Treasury bond has a long Macaulay duration of It has a Modified duration of That is a big price change and is a powerful illustration how lots of money can be made and lost by trading bonds.
It gives rise to another simple strategy that is often used by professional investors. Buy long-duration bonds if interest rates are expected to fall. Sell long-duration bonds if interest rates are expected to rise. If bond fund managers are worried that interest rates will rise they will often try to protect the value of their portfolio by buying more shorter-duration bonds.
Yes, the price of the bond will bounce around if interest rates change but unless the issuer of the bond defaults you will still get your coupons and your money back. Bond laddering avoids some of the risks of locking into a lower interest-paying bond investment if interest rates rise and bond prices fall. It is a possible strategy for people looking for alternatives to annuities when trying to produce an income from their pension pot.
Looking at bonds with SharePad You can use SharePad to filter for bonds just as easily as you can for shares. This might be a strategy used by a more risk-averse bond investor. SharePad has found 39 shares that meet these criteria. You could compare this bond with Tesco shares which currently pay no dividend.
The bond might look a better short-term investment than the shares as they have a higher income and stand less chance of big losses even if interest rates rise due to its very low duration. Be careful when chasing high bond yields High yields can be very tempting but they also usually come with higher risk. When it comes to bonds a high income yield may be offset by a big capital loss and low gross redemption yield. Also a bond may have a high yield because the company behind it is very risky.
Here you can see that there are a number of bonds with high income yields but low gross redemption yields because they are close to the end of their lives. Sometimes you can find bonds with high income and gross redemption yields. This can be a sign of a potential bargain but can also mean that the bonds are very risky. By looking in SharePad you can see that the bond price collapsed in You need to find out why this happened before you can even begin to think that the high yield is not a trap for the unwary.
The first thing you could do is to look in SharePad to see if EnQuest has listed shares as well as bonds as a company with shares will provide detailed financial information to investors. You can quickly find out that it does and that it is an oil exploration company which makes it a risky business. Its share price has been hammered as oil prices have fallen. In return the coupon on the bonds will increase from 5.
This shows that these bonds are probably very high risk and not for those who like to sleep well at night.
Investing in bonds chapter 13 online cricket betting uk
Chapter 13 Investing in Bonds
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