Investment: Bond

Investment: Bond
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What is a Bond?

Bond is another way to ensure steady income for the long term.
We may borrow money for various reasons whether to pay the cost of the vehicle or no small money for parking or not carrying a wallet.
Like us, state, local governments and companies often need to borrow money. Very difficult for companies to borrow money of what they want even if they promise to pay off. Besides promising to pay back some money they borrowed, the company also must pay a fee (interest) of money borrowed earlier.

A bond in financial language is a waiver of debt sold to the public. In return for lending money, people who lend money will get a piece of paper that mentioned the value of borrowed, the agreed interest rate, interest payment period and other agreements.

Types of Bond
Bond is also called fixed income security, because the amount of money that will be earned each period, has been 'fixed' or determined when sold. Whatever happens and whoever holds, the bond will yield the same value.

Types of bond issued according to sources of bond:

· Government . Government bond (municipal bond) is a debenture guaranteed by the government. This type of bond is issued in domestic and foreign currency . Because the government guaranteed it, the risk of default (not paid) bonds are almost non-existent.

· Private. Private companies sell the bonds to the public just as they sell shares. Companies have the flexibility to determine the amount of bonds to be issued and interest paid, although they should make it attractive to attract investors. Corporate bond interest is usually higher than government bonds, because the company could have gone bankrupt and fails to meet the promised agreement. Sometimes there are also so-called private convertible bonds, due to be exchanged for shares if the agreed criteria are met.

Par Price, coupon rate, and maturity
There are three important things we need to consider before buying a bond. They are par value, coupon rate and maturity. By recognizing these three elements, we will be able to analyze and compare bonds with other investment alternatives.

· Par Value is the amount of money that investors will receive when the bond reaches maturity date, meaning the company that had issued bonds will pay the full par value to bond holders.

· Coupon rate is the interest that will be received by holder of bonds each period expressed as a percentage of par value. For example: if the bond have a par value of $ 1,000,000. - with 10% coupon rate, bondholder will get the last $ 100,000. - a year. This coupon that is paid; can be each month (monthly), three months (quarterly), two times a year (semi-annually) and once a year (annually).

· Maturity Date is the date on which the company issuing the bond must return the loan principal to bond holder. After paying the loan principal, they have no obligation to pay interest. Sometimes the company decides to pay off bonds early before maturity. Almost all the private bonds indicate whether they have the option to make withdrawal and how fast they can do.

Yield is another name for the investment gain. Investors often ask keywords to compare bond investments with other investment alternatives. Yield is a benchmark of profitability of a bond, how is it calculated requires a special technique. Learn about how to calculate the yield here

If bond worths $ 1 million and pays interest on $ 75 thousand a year, means the current yield is $ 75 thousand divided by $ 1 billion or equals to 7.5%

$ 75,000

Current Yield = ------------------------------ = 7.5%

$ 1,000,000

Yield is not the same as coupon rate
Why we did not immediately see the coupon rate to determine the yield? Bond prices fluctuate in line with changes in interest rates. Therefore, investors can trade the bonds above or below par value. If you sell your bonds before maturity, you must sell the bonds at prevailing market rates, which may be above or below par value. Value will remain if you still held until maturity date; you will be guaranteed the money back.

Example:

· Suppose you buy a bond of company, in 1980 with 18% coupon rate, maturity period in 2005 with a par price of $ 1 million.

· Suppose that in 2000 rates fell to 12% and you are still holding these bonds so the bonds can be sold at a price above $ 1 million as the market expects interest only 12%, so the bonds will be traded at a premium price.

· Meanwhile, if in the year 2000 interest rates rose to 25%, then you need to sell these bonds under $ 1 million or a discount, because the market requires an interest rate of 25%.

The concept of the Yield to Maturity
Yield to maturity, sometimes abbreviated to the YTM, shows the total rate of return if you buy and hold bonds until maturity date.
YTM is different from the current yield because the bond can be purchased at or below the par value, because we buy bond at a price of $ 800 thousand, or $ 1.2 million and then $ 1 million gain when maturity. YTM does not just count all the income from interest until maturity, but also assumes that we can reinvest the interest income at the same level of yield and considering the current market price and the difference between par prices of bond.

If you buy bonds at market price, the YTM will be equal to current yield. YTM will be very important in calculating the value of zero coupon bond, the type of bonds that do not provide interest payment but are sold with a huge discount. Because zero coupon bond has no yield, it is calculated with YTM.

Bond interest is relatively higher than bank deposit rate, but still there are some things to know about bonds before you invest.

You need to know about bonds,

· Bonds are not always safe. Many people buy bonds because considered as a safe investment. Except for government bonds and government has guaranteed them, all bonds have default risk for companies that issued bonds that are not able to pay interest or principal. Usually a time of crisis, this often happens.

· Try to buy in the primary market. Buying bonds in the primary market or when in the first offer, the bonds are sold at wholesale prices. If they are purchased in the secondary market sometimes you have to pay fees and mark-ups in high price to the broker.

· Yield and price of bonds always move antagonisticly. If interest rate rises, bond price will fall and yield will rise, and vice versa.

· Zero Coupon Bond. Non-interest bonds sold by large discount when issued. These bonds continue to rise close to the maturity date. For these bonds, fair price is the Present Value of the par value, using the discount rate (yield) of the market.

Example: A company issues zero coupon bond with a par value of $ 1 million 10-year maturity. If the current market yield is 15% then the bond will be sold at a price of only $ 247 thousand for a 15% YTM.