Analyzing The Best Retirement Plans And Investment Options: Bonds
AAA
  1. Analyzing The Best Retirement Plans And Investment Options: Introduction
  2. Analyzing The Best Retirement Plans And Investment Options: Annuities
  3. Analyzing The Best Retirement Plans And Investment Options: Bonds
  4. Analyzing The Best Retirement Plans And Investment Options: Cash Investments
  5. Analyzing The Best Retirement Plans And Investment Options: Direct Reinvestment Plans (DRIPS)
  6. Analyzing The Best Retirement Plans And Investment Options: 401(k)s And Company Plans
  7. Analyzing The Best Retirement Plans And Investment Options: Exchange Traded Funds (ETFs)
  8. Analyzing The Best Retirement Plans And Investment Options: Individual Retirement Accounts (IRAs)
  9. Analyzing The Best Retirement Plans And Investment Options: Mutual Funds
  10. Analyzing The Best Retirement Plans And Investment Options: Stocks
  11. Analyzing The Best Retirement Plans And Investment Options: Conclusion

Analyzing The Best Retirement Plans And Investment Options: Bonds

  • What they are: Debt securities in which you lend money to an issuer (such as a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value.
  • Pros: Certain bonds are risk-free (many are low-risk); predictable income; better returns compared with other short-term investments; certain bonds are tax exempt.
  • Cons: Potential for default; selling before maturity can result in a loss.
  • How to invest: Over-the-counter (OTC) markets including securities firms, banks, brokers and dealers. Some corporate bonds are listed on the New York Stock Exchange. U.S. government bonds can be purchased through a program called Treasury Direct (www.treasurydirect.gov).

Bond Basics
A bond is an IOU issued by a corporation or government in order to finance projects or activities. When you buy a bond, you are extending a loan to the bond issuer for a particular period of time. In exchange for the loan, the issuer agrees to pay you a specified interest rate (the coupon rate) at regular intervals until the bond matures. In general, the higher the interest rate, the higher the risk for a bond. When the bond matures, the issuer repays the loan and you receive the full face value (or par value) of the bond.
 
As an example, assume you buy a bond that has a face value of $1,000, a coupon of 5%, and a maturity of 10 years. You will receive a total of $50 of interest each year for the next 10 years ($1,000 * 5%). When the bond matures in 10 years, you will be paid the bond’s face value; or $1,000 in this example.
 
As an alternative, you could sell the bond to another investor before the bond matures. If interest rates are more favorable now than when you bought the bond, you may take a loss and have to sell at a discount. If interest rates are lower, however, you may be able to sell the bond at a premium (since your higher-interest bond is more attractive). The price for the bond in the previous example (with a face value of $1,000, a 5% coupon, and a 10-year maturity) would decrease if bond rates rose to 6% or increase if bond rates fell to 4%. You would still, however, earn the 5% coupon and receive full face value if you decided to hold onto the bond until it matures.
 
Bond Risk
Bonds expose investors to several types of risk, including default, prepayment and interest rate risk.
 
Default Risk
The possibility that a bond issuer will not be able to make interest or principal payments when they are due is known as default risk. While many are considered no- or low-risk (such as short-term U.S. government debt securities), certain bonds, including corporate bonds, are subject to varying degrees of default risk. Bond rating agencies, including Fitch, Moody’s and Standard & Poor’s, publish evaluations of the credit quality and default risk for many corporate bonds.
 
Prepayment Risk
The possibility that a bond issue will be paid off earlier than expected is known as prepayment risk. This often occurs through a call provision. Many firms embed a call feature that allows them to redeem, or call, the bond before its maturity date at a specified call price. This feature provides flexibility to retire the bond early if, for example, interest rates decline. In general, the higher a bond’s interest rate in relation to current rates, the greater the risk of prepayment. If prepayment occurs, the principal is returned early and any remaining future interest payments will not be made. As a result, investors may be forced to reinvest funds in lower-interest rate bonds.
 
Interest Rate Risk
Interest rate risk is the possibility that interest rates will be different than expected. If interest rates decline significantly, you face the possibility of prepayment as firms exercise call features. If interest rates rise, you risk holding a bond with below-market rates. The longer the time to maturity, the higher the interest rate risk since it is difficult to predict rates farther into the future.

Analyzing The Best Retirement Plans And Investment Options: Cash Investments

  1. Analyzing The Best Retirement Plans And Investment Options: Introduction
  2. Analyzing The Best Retirement Plans And Investment Options: Annuities
  3. Analyzing The Best Retirement Plans And Investment Options: Bonds
  4. Analyzing The Best Retirement Plans And Investment Options: Cash Investments
  5. Analyzing The Best Retirement Plans And Investment Options: Direct Reinvestment Plans (DRIPS)
  6. Analyzing The Best Retirement Plans And Investment Options: 401(k)s And Company Plans
  7. Analyzing The Best Retirement Plans And Investment Options: Exchange Traded Funds (ETFs)
  8. Analyzing The Best Retirement Plans And Investment Options: Individual Retirement Accounts (IRAs)
  9. Analyzing The Best Retirement Plans And Investment Options: Mutual Funds
  10. Analyzing The Best Retirement Plans And Investment Options: Stocks
  11. Analyzing The Best Retirement Plans And Investment Options: Conclusion
RELATED TERMS
  1. Accelerated Return Note (ARN)

    A short- to medium-term debt instrument that offers a potentially ...
  2. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  3. Contingent Annuitant

    Someone designated by an annuitant to receive the annuitant’s ...
  4. Living and Death Benefit Riders

    Living and death benefit riders are a descriptive class of contractual ...
  5. Dividend

    A distribution of a portion of a company's earnings, decided ...
  6. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  1. What is the difference between drawdown and disbursement?

    Learn about some of the many definitions for financial drawdowns and disbursements, which represent transfers of funds between ...
  2. What happened to Bernard Baruch's estate after his death?

    Learn what became of financier Bernard Baruch's multimillion dollar estate upon his death in 1965, and learn about his philanthropic ...
  3. How do I use the principles of convexity to compare bonds?

    Read a brief overview of bond duration and bond convexity and why bondholders should take these into consideration when deciding ...
  4. How are new exchange traded funds (ETFs) created?

    Read about how exchange-traded funds are proposed to the SEC, created with underlying assets, sold to authorized participants ...

You May Also Like

COMPANIES IN THIS ARTICLE
Related Tutorials
  1. Taxes

  2. Fundamental Analysis

    Ethical Investing Tutorial

  3. Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  4. Bonds & Fixed Income

    Certificates Of Deposit

  5. Retirement

    Consolidating Your Retirement Money

Trading Center