Investing in Corporate Bonds and Government Bonds
While stock markets have suffered during recent economic turmoil, bond markets have been more secure. They have not been immune to the banking troubles, but should be far more resilient to further trouble.
This article looks at how to gain exposure to the bond markets and how to work out what to buy for your personal financial requirements, to create a low risk balanced portfolio or for more complex financial engineering
Bonds are generally lower risk than equities, but also come in a wide range of risk-profiles, from low risk Government bonds from stable countries and AAA rated corporate debt to High Yield or "Junk" Bonds at the other end of the scale.
Related corporate bond article published on Helium.com
Table of Contents: Investing In Bonds
- Disclaimer
- What Are Bonds? The Basics
- Bond Investment Books
- Balanced Portfolio Management
- Related Portfolio Management Articles
- Bonds, Funds or ETFs
- Investment Books
- Related Finance Articles
- Corporate Bonds or Government Bonds?
- The Duration of a Bond or Fund
- CafePress
- Please Leave Some Feedback
- More Finance Lenses
- About Me
Disclaimer
What Are Bonds? The Basics
Skip this bit if you already know
Bonds can be traded after they have been issued and may have a value above or below the issue price so the coupon (yield) may be more or less than the original published yield and you may make a loss or gain if you hold to matturity. The Gross Redemption Yield is the effective percentage yield you will get if you do hang on to them until expiry (This value is available in financial publications and web-sites)
The value of the bond depends on how the apparent solvency, credit rating and bank interests rates have changes since issue (See below)
Bond Investment Books
Bonds: The Unbeaten Path to Secure Investment Growth
Amazon Price: $16.47 (as of 11/27/2009) 
The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More
Amazon Price: $19.77 (as of 11/27/2009)
How to Invest the Smart Way: In Stocks, Bonds & Mutual Funds
Amazon Price: (as of 11/27/2009)
Balanced Portfolio Management
Why you should buy bonds to balance your stock/share portfolio
The risk of buying a single share or bond is high with many possible unknown influences on the price. Buying two bonds results in some reduction of risk because a drop in one price may not affect the other one adversely. Many shares/bonds are highly correlated to each other, so having two shares/bonds in the same field (e.g. BP and Shell) does not reduce the risk as much as two shares/bonds in unrelated industries (e.g. BP and Lloyds) Mixing shares with other asset-classes will also improve volatility of the over-all portfolio (e.g. mixing shares, bonds, property and gold bars)
Please see the separate balanced portfolio article...
Related Portfolio Management Articles
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Make Money In Any Market: Balance Your Portfolio
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What is a "balanced" portfolio? Why should mixing different asset classes make your investment portfolio much less risky? Here is an explanation (and some of the maths) behind this useful risk reduction method. Most portfolios are highly...
Bonds, Funds or ETFs
How to buy corporate bonds
Individual bonds can be purchased via a broker, in the same way you might buy shares, stocks etc. or you can buy bond-funds, mutual funds, unit trusts, investment trusts or Exchange Traded Funds - ETFs (or Zeros a more obscure bond-like alternative)To diversify risk, as described above, you need exposure to a range of different bonds; if you want to buy many bonds in a relatively small portfolio you would incur a lot of charges from your broker. For instant exposure to bond markets ETFs (exchange Traded Funds) provide low cost exposure to whole markets or sub-sets of bond markets. For a managed, diversified exposure us mutual funds, unit trusts etc. which have higher charges (typically above 1% annual charge)
For more information about stock-brokers and trading shares/bonds, see this related article
Investment Books
Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money--That the Poor and the Middle Class Do Not!
Amazon Price: $4.95 (as of 11/27/2009)
Rich Dad's Guide to Investing: What the Rich Invest in, That the Poor and the Middle Class Do Not!
Amazon Price: $12.99 (as of 11/27/2009)
RICH DAD POOR DAD
Amazon Price: (as of 11/27/2009)
Bond Investing For Dummies (For Dummies (Business & Personal Finance))
Amazon Price: $16.49 (as of 11/27/2009)
Asset Allocation For Dummies (For Dummies (Business & Personal Finance))
Amazon Price: $16.49 (as of 11/27/2009)
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Financial Engineering is a complex process used by large companies to ensure that they can fulfill their financial obligations at certain times in the future. It is however just as relevant for individuals and small companies. We cannot accurately...
Corporate Bonds or Government Bonds?
Which are better, Corporate Bonds or Government Bonds?
Government bonds pay out a defined sum every year or half year (The "coupon") and a final sum on maturity on a predefined date. The income and final payment is predictable and governments of stable countries rarely default on their payments. Corporate bonds are similar and bond holders will always be paid first, before share-holders (but after any bank debt is paid), even if the company gets into financial trouble, but the health of a company's finances must always be taken into consideration.Governments and corporate bonds are rated by rating agencies (Moody give ratings: Aaa to B3 and S&P and Fitch give AAA to CCC-) to indicate the chance of default. A bond rated at AAA or Aaa is extremely unlikely to default, AA/Aa1, A/A2, B/Ba2 or CCC/B3 are increasingly more likely to. Low rated bonds (rated Ba1 to B3 or BB+ to CCC-) are often called high-yield, Sub-investment grade or Junk bonds; the coupons are high to compensate for the chance of default. Higher rated bonds with low chance of default are called "investment grade bonds" (Aaa to Baa3 or AAA to BBB-)
Corporate bonds, in general, pay a higher yield depending on the perceived quality of the company. Alternatively Zero Dividend Preference Shares (See related article) provide the same function, but producing no income (zero dividend) producing their return entirely from capital gain - i.e. paying a predefined amount on a certain day in the future. These are ideal for financial planning and tax planning.
The Duration of a Bond or Fund
Here's some maths, but ignore this if you prefer - the value of the Modified Duration is often published for each bond or fund, so knowing how it is calculated is not important
The duration concept was developed by F. Macaulay
Macaulay duration = SUM((PV(Cash Flow).t/P0)
where
(PV(Cash Flow) = the present value of cash flow to be received at time t
P0 = current price of the bond
Modified Duration = Mac_D/(1 + r)
where
r = yield to maturity
Investing in individual corporate bonds is fairly risky in that the company could default or go bust, so a portfolio of bonds would help to reduce the risk or better still a managed bond fund (e.g. an Exchange Traded Fund or ETF, mutual-fund, unit trust or OEIC) Unfortunately these do no have a defined end date, but they will have a average "duration" value published, just like any bond, which defines the weighted-average amount of time for the bond or fund's cash-flows to be received by the investor (i.e. how long before half of the total payout - coupons and redemption value - is received) Choosing an ETF with a similar duration to your ideal individual bond would give a similar effect. The lower the duration the less risky the bond or fund and the lower the sensitivity to the bank base rate - as bank base-rate goes up generally the bond-price goes down and vice versa:
Change in Bond-Price = -(Duration) x (Bond Price) x (Change in Bond Yield)
or more forally: dP = -(ModD)(P0)(dr)
Zero Dividend Preference Shares behave like a zero coupon bond which makes them far easier to use: no complicated duration calculations to worry about because all of the payout is at the end on the predefined end-date.
Related corporate bond article published on Helium.com
CafePress
Please Leave Some Feedback
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Reply
- Tipi Tipi Jun 4, 2009 @ 7:10 pm
- Very good, clear and well written. I'm going to take this link with me! :)
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- daria369 daria369 Mar 8, 2009 @ 7:50 pm
- Excellent lens - as always!! :)
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- QueSea QueSea Mar 6, 2009 @ 3:37 pm
- It seems like a lot of folks are shifting from stocks to bonds here in the U.S. these days. Some major investors have done so even at zero percent return in the short run.
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Reply
- sandyspider sandyspider Mar 6, 2009 @ 11:26 am
- Great share and timely too. Thanks.
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