The Federal Reserve, consistent with its dual mandate of pursuing full employment and stable prices, has been conducting aggressive monetary policy driving interest rates to historically, low levels. This action by the Fed has triggered large gains in bond prices. As a result, most bonds are now actually trading at what is known as a "premium" ;.Premium bonds are misunderstood by the retail investor who typically focuses their attention primarily on the dollar price of the bond in place of its yield. invest bonds UK
Bonds are normally issued in $1,000 face value increments. A connection selling at below face value is reported to be selling at a "discount" ;.A connection selling at its face value is reported to be selling at "par", and a connection selling for significantly more than its face value is reported to be selling at a "premium" ;.Do not confuse these terms (discount, par, premium) with levels of quality or value. A connection selling at reasonably limited does certainly not allow it to be better or for example higher priced on a member of family basis when compared to a bond selling at par or a discount. Those terms are just used to spell it out the bonds current price relative to its face value. So, if the dollar price of a connection really doesn't express its' relative value, how do an investor compare bonds? That answer may lie in the bond's yield.
Yield takes under consideration the cost, the maturity, and the coupon rate. Yield is an incredibly important concept in bond investing that's typically overlooked by retail investors, who make value judgments by solely focusing on the dollar price. Yield is a significant tool to measure the return of 1 bond against another [other things being equal, like credit ratings, call features, and/or the maturity date]. In essence, "yield" is the rate of one's return in your investment. Professional dealers and traders, when buying and selling bonds together, usually quote prices in yields not dollars; yield provides you with an instantaneous research the relative value in comparison to other bonds. When considering yields, here are some useful tips to look for value:
- Compare the yield of the bond you are considering to other similar investments. Bonds are not as liquid as stocks and, many times, you will find value by comparing.
- When evaluating various maturities of exactly the same bond, consider the incremental yield (the spread) you'd be receiving by purchasing the longer maturity and make sure you feel it's worth the excess risk. Yields are quoted in basis points: 1 basis point is 1/100th of 1 percent; 100 basis points is equal to 1%. As an example, if you are comparing a 15 year bond with a 30 year bond, and the 30 year bond yields only 5 basis points more, that is probably not worth the excess risk.
- Higher rated bonds will usually give you a lower yield, other items being equal. If you should be evaluating a diminished rated bond, make certain the excess yield you'd get (the spread) with the lower rated bond is worth the excess risk.
- Don't get swept up in a certain maturity date. As a result of way bonds are traded, it's very possible to get a bond with a shorter maturity that gives better value, other items being equal.
- In this interest rate environment, consider purchasing higher coupon bonds (Premiums) which usually are more defensive should interest rates rise earlier than anticipated. But keep in mind when interest rates remain as is or go lower for an extended time period, bonds with call features might be redeemed earlier than everything you had anticipated.
