3 Things to know about bonds
At first glance, bonds are simple IOUs – a promise from issuers to repay the debt plus interest. In fact, bonds are complex instruments whose prices – or face value – are affected by what's happening in the economy, interest rate, underlying issuer and other securities.
These three variables apply to all bonds and are worth understanding even if you do not plan to buy individual bonds: quality, dividend and tax.
Understanding Credit Credit Ratings
How safe can you be that you will receive your interest payments on time and that the principal will be paid at maturity? The responses depend on the issuer's creditworthiness.
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Very few investors are able to make their own credit research so they rely on rating agencies such as Moody's & Standard & Poor's. There are similar but not identical scales for rating all bonds except the US governments, which are believed to be of the highest quality. Credit ratings range from Aaa (Moody's) or AAA (S & P) given to the most creditworthy issuers to C, which is the lowest rating of high yield bonds (also called junk bonds). Moody's adds a D category for bonds that are already in default. (You can buy those with a deep discount in the hope that the issuer will recover. Mostly, this type of thing is better for professionals, though.)
Remember that Moody's & S & P is not infallible. During the housing bubble, the top ratings yielded almost worthless mortgage bonds. Quality rating affects the rate that the bonds pay. It is not uncommon for a C-rated junk bond to pay a rate of 50% over the interest paid with a triple A-rated bond. Investors demand greater dividends in return for the risk. One of the risks of investing in bonds is the possibility that an issuer's rating will be downgraded during a bond. When that happens, the value of the bond falls. The opposite happens if the bond loan's credit rating is upgraded. These are important considerations in actively managed portfolios, but less so for buy-and-hold investors. If a bond is held to maturity, the investor will be paid the full face value as long as the company remains solvent.
Basis of bond maturity
The maturity of the limitation is the date of principal or face amount will be repaid to the investor. Since bonds can be bought and sold many times after they are issued, the maturity time is usually more important than the maturity itself – because it is a key factor in a bond's sensitivity to interest or duration.
In most circumstances, for bonds of the same quality, the longer the maturity, the higher the yield. This compensates the investor for the risk of inflation, which increases the longer the bond is held. When there are irregularities in the bond market, this simple relationship can change as investors are exposed to new challenges – or new opportunities.
Give opinion on dividends
The dividend is the interest paid by a bond. This is expressed as a percentage of the face fee: in other words, a 3% rate on a $ 10,000 bond means $ 300 a year in interest. But investors rarely pay the exact amount of employment for the bond. Depending on the supply, demand and market interest rates at the time of purchase, investors can buy it for either a premium or a discount.
If e.g. Interest on identical bonds rose to 4%, no investor would pay $ 10,000 to get a 3% payout as he could buy a bond that paid 4%. The price of the older, 3%, bond will fall to $ 7,500. The 3% payout of $ 7,500 is $ 400, the same as 4% of $ 10,000.
Thus, the current yield is the interest rate shown on the coupon – the fixed periodic interest paid by a bond – divided by the price investor actually paid for the bond.
Surplus does not affect the impact of taxes
Bond yield payments are considered income and taxed at the same rate as your salary or other income. In tax planning, it is assumed that the tax rate is your highest margin. Note that capital gains and losses on bonds receive the same tax treatment as other gains or losses. So, if you had a bond for more than a year and sold it for profit, it would be taxed on long-term capital gains which, for high-income investors, are lower than regular revenue.
Many financial advisers recommend that people with high wages – any in the 28% tax bracket or above – keep the bond portion of their portfolios as much as possible in their tax-depreciated accounts, such as the IRA and 401 (k) s. be more effective in taxable accounts as dividends receive favorable tax treatment. In addition, the shares are more volatile, giving investors more opportunities to sell at a loss, lock a tax deduction and buy similar (but not identical!) Assets to maintain a stable market exposure.
] Bond: A negotiable security records the terms and conditions of a loan made by an investor to a borrower.
Coupon: The fixed periodic interest paid by a bond, so-called because bonds were once issued with removable coupons that could be deposited in a bank when they happened.
Denomination: The amount of a bond will repay upon maturity, also called Par Value. Not to be confused with the face value of the shares, which is usually a negligible amount used for accounting purposes. Bonds are often bought and sold at a premium or discount from face value. Interest is calculated as a percentage of face value, but the dividend is the percentage you actually earn from what you pay for the bond.
Fixed Income: For investment, a term is used to describe bonds or other instruments that pay fixed interest of interest over specified periods of time.