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Chapter 6: Factors to Consider Before Buying Bonds

Many of the same factors that affect stock prices also influence bonds but differently. For instance, when the economy is struggling, bond prices are usually high because people prefer to invest in safer instruments than stocks. Conversely, when interest rates go up and the economy is on a roll, bond prices fall.

Investors are more confident of putting their money in riskier options and reduce their exposure to bonds. These factors must be taken into account in your buy or sell decision. There are several other factors that you need to consider before investing in bonds.

Credibility of the Issuer

One of the most important assessment factors when buying a bond is who the issuer is. Just as you would assess any potential borrower before you lend him money, you need to assess the repayment capacity of the issuer too.

Stability of the issuer is the first thing you should look at. Companies that have been around for decades, have strong financials and a sound business strategy are not likely to close shop in the next economic downturn. Bonds issued by these companies are a good investment option.

Another good way to determine if a company will remain successful for a long period is to look at the market that it operates in. If the company offers essential services like telecom or manufactures critical products like medical equipment then its business will remain somewhat insulated from economic downturns. This lower market risk will also be reflected in bond prices.

When it comes to issuer credibility, there is no better option than government bonds. These are backed by the US government and are classified as no risk investments because the government is not likely to default on payments.

To help you compare risk with various bond offerings, credit rating agencies come up with ratings of bonds. Ratings issued by agencies like Moody’s, Standard & Poors and Fitch can tell you how a particular bond is expected to perform and how much risk is associated with it. The rating denotes the credit quality and represents the likelihood of timely and full repayment.

A bond which has been rated ‘AAA’ is among the best in the market. ‘AA’ bonds are also a very safe investment. Bonds with the lowest rating (typically C or D) should be avoided if you are risk averse. You can check a bond’s rating online or in a newspaper before you decide to buy it.

The yield to maturity of a bond (usually referred to as yield) lets you measure the actual return on investment that you will get from it. If you hold your bond until maturity, the yield is the annual rate of interest that youll earn on your investment until the bonds maturity date. For a bond selling at its par value, the yield will be equal to the coupon rate. Yields help you compare various bond products accurately, though you would also have to consider other factors like the bonds rating.

When you refer to a bond table in a newspaper or on a website to find out the current price of a bond, it will also mention the yield of the bond, the maturity date, the issuer of the bond and the coupon rate. This information will give you a starting point for further analysis into whether that bond is the right investment for you and how it compares to other bonds available in the market.

The bond market offers a wide range of products to cater to different lock in period preferences, risk appetites and return expectations. The assurance of a minimum return and a greater certainty of principal repayment are the biggest benefits of bonds when compared to stocks. Although the success of stocks in a strong economy can probably not be matched with investment in bonds, the stability and consistent returns make bonds an indispensable part of a good portfolio.