A Simple Guide to investing in Bonds
Bonds are financial instruments issued by the government, companies or institutions in exchange for money paid by the investor (Bond Owner). A bond is a fairly secure investment option which yields interest at a fixed rate (coupon rate). This interest is paid out at predetermined terms, which often could be monthly or quarterly until the maturity of the principal.
Granted that the bond is acknowledged as safe, relative to other investment options, it is important to understand that situations may arise that may result in delayed payment or in some extreme cases, a total loss of investment. Just as it is commonly said Nothing is permanent. Bonds sometimes like other capital market investments are victims of systemic failures. There have been historical instances where the issuers of bonds are unable to meet their obligation to the investors by reason of a catastrophic loss arising from wars, natural disasters or economic depressions.
In consideration of the fact that the interest rate is fixed for the entire life of the bond, an investor has to necessarily consider some basic factors before deciding on a line of investment. Since the coupon rate at which a bond is purchased does not appreciate or decline with the market interest rate, it would imply that a rise in interest rate will have a corresponding negative effect on the earnings from the bond in consideration of the fact that the coupon rate is static while the general market interest rate is dynamic and subject to fluctuations. This would in effect result in a decrease in the dollar amount paid the investor at maturity of bond.
The bond agreeably is safe but it has its downsides. An investor should always monitor and use the capital market as baseline and denominator of what investments to make. A good investor should buy when and if the coupon rate is high. This serves the purpose of adding value to the interest earning potential of the bond. This takes a simply understanding and application of the basic laws of demand and supply. With the bond, the guiding rule is to keep buying and selling as the market interest rate appreciates. While patience and persistence is a known attribute of successful investors, one should not lose sight of the fact that patience and persistence must be guided and based on information and knowledge. The investor should therefore get as much information as possible on the earning potentials of any investment and this requires and demands a good dose of flexibility. The investor must know when to enter and when to exit. The depths of knowledge available to the investor determine the quality of choices and eventual soundness of business decisions made.