There are many different types of bonds. They can be US government bonds, municipals, mortgage and asset-backed funds, foreign bonds, and corporate bonds.
Corporate bonds are given by companies and can be either publicly traded or private.
Meanwhile, bond rating services calculate the risks inherent to every bond issue, as well as the chances of default or failure to pay. They assign a series of letters to rate each issue signifying its risk factor.
Examples of bond rating services include Standard & Poor’s, Moody’s, and Fitch.
A rating of triple A, or AAA, refer to the most reliable and least risky bonds. A triple B, or BBB, and below are among the riskiest bonds.
Bond rating services calculate the ratings using many different variables such as financial stability, current debt, and growth potential.
In a well-diversified investment portfolio, investors can take advantage of highly-rated bonds of short-term, mid-term, and long-term maturities. These bonds can help them accumulate money for retirement, save for children’s college education, or establish a cash reserve for emergencies.
Buying and Selling
Investors can buy and sell corporate bonds on the over-the-counter (OTC) market. Many of them also provide great liquidity, which is the ability to quickly and easily sell the bond and convert it to cash.
This is very important particularly if the trader wants to get active in his or her portfolio.
Investors may buy the bonds from the OTC market or get them through initial offerings from the issuing company in the primary market. Oftentimes, OTC bonds are sold in $5,000 face value.
Meanwhile, purchases in the primary markets may be made from brokerage firms, banks, traders of bonds, and brokers. All of these take a commission, or a fee expressed in percentage of the sale price, for the facilitation of the sale.
The interest payments on bonds are usually given every six months. Coming from the highest-rated of bonds, these interest payments can be a reliable source of income. Meanwhile, bonds with the least risk whip out lower rates of return.
Higher risk bonds usually pay a higher return to attract more lenders, but they are ultimately unreliable.
When bond prices decrease, the interest rate increases because the bond costs less. However, the interest rate stays the same as its initial offering.
On the flipside, when the price of bond increases, the effective yield goes down. Long-term bonds often offer a higher interest rate because of the unpredictability of the future.
The business’ financial stability and profitability may change over the long term and not be the same as to when the bonds were first issued.
To minimize this risk, bonds with a longer-term maturity usually pay higher interests.
Meanwhile, a callable or redeemable bond may be redeemed by the issuing company before the maturity date. The downside is for investors, since if a high-yield bond is called, they will lose the interest returns for the remaining years in the life of the bond.
On the other, there are times when the firm calling a bond will pay a cash premium to the investor or the bond holder.