In the same way we did to pick a share, if we are thinking in buying a bond, we have to make sure first that we understand what it is, and then get yourself time to research and collect information about the features of the bond and how the company that issued it is doing. We think that most of our equipment for the journey to our #imapGoal should be composed by funds, but if we see an opportunity that fits to our profile and to our goal, then we should be prepared with some information to make the decision.
What are the main features of a bond?
Nominal value is the value given to a bond by the issuer company, typically $1,000 or $100 for each bond. It doesn´t change from the issue date until the due date.
Coupon is the amount paid by the issuer company, usually expressed in terms of coupon rate. It doesn’t change from the issue date until the due date. For example, a $1,000 bond with a coupon rate of 7% pays a coupon of $70 a year.
Price of the bond is what is paid for a bond at any time between the issue date and the due date, that for several reasons can be different from the nominal value of the bond.
Interest yield, or coupon rate, is is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity, that is to say, the relation between the coupon and the price at a given moment. Because bonds can be sold before they mature, causing their price to fluctuate, the yield will usually diverge from the bond's coupon. For example, at issue, the $1,000 bond described above yields 7%; that is, its current and nominal yields are both 7%. If the bond later trades for $900, the current yield rises to 7.8% ($70 ÷ $900).
Prices and interests can change for different reasons as we said, but we can identify some general reasons: when inflation is on the rise, bond prices fall, and when inflation is decreasing, bond prices rise; when interest rates rise, bond prices fall, and when interest rates fall, bond prices rise; and if the issuer’s credit rating goes up, the price of its bonds will rise, and if the rating goes down, it will drive their bond prices lower.
Maturity date is the date on which the principal amount of a bond becomes due. On this date the investment is repaid to the investor, while the interest payments that were regularly paid out during the life of the bond, cease to roll in.
When you sale a bond before it’s maturity date it can trigger capital gains or losses, the same as it happens with shares.
Payment periodicity refers to the number of payments when you receive a coupon within a year. Typically these interest payments are semiannual, meaning that you will receive the coupon twice a year.
Tax status, refers to the taxation applied to the coupon amount and to the gains generated when selling a bond before its maturity date. While the majority of corporate bonds are taxable investments, some government and municipal bonds are tax-exempt, so income and capital gains are not subject to taxation. Tax-exempt bonds normally have lower interest than equivalent taxable bonds.
What is the solvency of the bond issuer to pay back both invested and coupons?
Working Capital represents a company's ability to pay its current liabilities with its current assets. It is an important measure of financial health since creditors can measure a company's ability to pay off its debts within a year.
Interest Coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt.
Credit rating is a letter-based credit scoring scheme used to judge the quality and creditworthiness of a bond.
Other considerations when picking a bond.
Currency, when a bond is not denominated in its domestic currency. As currencies are more volatile than bonds, currency returns for a foreign currency bond can end up dwarfing its fixed-income return.
These are the main indicators for bonds. Depending on the company industry and if you want to dig deep, you may need to look at other indicators, like for example the current yield, IRR or YTM. You can read Security Analysis written by professors Benjamin Graham and David Dodd of Columbia Business School if you want to master this part.
Does this look a lot of work? Learn how using funds can help you simplify this process and save lots of times and headaches. And remember, whatever the equipment that you choose for your journey, always understand what you are doing.
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