Should You Prefer Bonds?How’d you like to loan General Motors some money. You can, and they could use it. Whether they'll pay you back is another story. When a corporation or government issues a debt instrument, they call them bonds. When you buy a bond you’re lending money at a an interest rate for a set period of time. Bonds are purchased through fixed denominations. Usually a $1,000 each. When a company decides to raise money through bonds they don’t offer them directly to the public. Investment banks will buy these debt instruments and sell them to institutional investors; who in turn sell them to the public. Discount brokers usually do not carry a deep inventory of bonds. You must go to an established firm or bond dealer. Prices are kept relatively secret so dealers can maintain their competitive advantage over one another. Although some information can be found from online exchanges or the web, it’s better to have a good relationship with a broker. If you decide to lend the government or some large company money, here are some terms to be familiar with: Par - The value of a bond at maturity. Usually $1,000 Discount - When a bond sells for less than par. Premium- A bond selling for more than par. Bid - If you are selling a bond, this is the price you’ll get. Ask - Looking to buy? This is what it’ll cost. Spread - This is the difference between the bid & ask price. Bond dealers call it “commission.” Basis Point - 1/100th of one percent. 100 basis points = 1%
As boring as bond investing may be, there are risks. The first is default risk. What are the chances that the issuing company goes bankrupt? If the company is in less than stellar financial shape, a credit rating agency may assign them a low rating. Standard & Poor’s, Moody’s and Fitch are the largest credit rating agencies. If they give a bond a less then A rating, that implies some risk involved. The only good news to come out of that is you get paid a higher interest rate. If the rating is BB, B, CCC, CC you're the proud owner of a "junk bond." If an agency downgrades a bond’s rating, the price of the bond will drop; and the interest rate will rise to compensate you for taking on more risk. The other risk is interest rate risk. A change in the value of interest rates will affect the value of your current bond holdings. If you own a bond at $1,000 par with a 6% coupon rate, you make $60 a year interest. If a year later similar bonds are issued that pay 8%, you'll have trouble selling your bond at what you paid for it. If an investor can invest $1,000 and make 8%, why should they buy your bond and make 6%? If your bond is sold at a discount (less than a $1,000), you’ll get a sale. 
If the market rate of interest should drop to 4%, you can sell your bond at a premium (after all, you do own a bond paying 6%). If you hold your bond till maturity, then no worries. You’ll make 6% and get your $1,000 back no matter what the market does. Inflation risk. What if the rate of inflation (interest rates) is on the rise. When this happens your coupon payments aren't worth as much. If you are in an inflation prone environment, variable rate bonds are the way to go. Another strategy to use during times of inflation is to buy short term bonds. This way you can move your money to a higher paying instrument when they mature. Once you earn the interest payment, what do you do with it? The smartest thing is to immediately reinvest it. Bonds are not the highest paying returns in town. By reinvesting the coupon payments you magnify the returns. Present Value - What is the current value of receiving a series of future income payments today. If you expect to receive $500 a year for the next 20 years, what would the value be worth if you had the total amount right now. Future Value - What is the value of an asset or stream of cash flows in the future. This is used to compare different investment alternatives. Duration - This measures the sensitivity to a change in interest rates as it relates to the price of your bond. Duration is expressed in years. The longer the duration the more volatile the bond price.
When The Fed raises the discount rate (the rate charged to banks to borrow money from the Federal Reserve Bank), there is an effect on the stock market. When the cost of capital increases, it costs companies more to borrow and grow. This may depress a stock price. Most times, just the announcement itself to raise interest rates is enough to drop the market as a whole. Why invest in bonds? Income, preservation of capital. The U.S. government offers a variety of long and short term bonds. Hell, China can’t get enough of them. If you're young, wild, crazy and free, you don't need to invest in bonds just yet. If you’re considering putting a percentage of your portfolio in fixed income, a bond mutual fund might be best. The transaction costs of buying individual bonds are high. If you have money that needs tax-free protection, consider a tax-free municipal bonds. Let's be real about this. Over the long term, stocks will outperform bonds. However, if you need safety and want to decrease your tax liability, a municipal bond fund purchased within the state you live is the answer.
Yes that’s David Bowie. In 1997 David Bowie released the Bowie Bonds. These are asset backed securities of his first 25 albums. In effect, David Bowie sold the royalties of his songs in exchange for an immediate payment of $55 million from Prudential Insurance. After 10 years, all royalties would revert back to him. Unfortunately, Bowie Bonds are not available to individual investors. Other artists have followed suit and securitized their collections as well. Go From Bonds To Financial Products
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