Bonds are best likened to an IOU that you receive in return for lending your money to either a company or government. This IOU serves as an acknowledgement that your money will be repaid with interest on a predetermined date. Bonds can serve as a useful means of safeguarding your capital because you know the rate of interest that you’ll receive later. Bonds are an appealing investment, but do bear in mind that not all companies (and sometimes governments) can be trusted to make good on this promise. Take, for example, energy company Enron. Moody’s were still rating Enron’s bonds investment grade four days prior to the company’s collapse, and while this was arguably through no fault of the credit rating agencies (having been misled by the reported financial figures from the company), it does serve as a case in point for exercising caution with regards to large bond investments. Companies are rated on their financial reliability through two main rating agencies; Moody’s and Standard & Poor’s. The rating system categorises companies into variations of A, B, C and D. The former describes companies with a strong financial standing and a high likelihood of delivering on their promise. A BBB rating forms the threshold for ‘investment grade’ companies, and anything below (like D) is considered a ‘junk’ or ‘high-yield’ investment.
How do you trade bonds?
Bonds are debt instruments, so they are typically considered a long-term investment, so as to allow for an accumulation of interest. Bond maturity is categorised by three ages, shorts, mediums and longs. Shorts typically stand at around 7 years before you can reclaim your money with interest, while mediums and longs can be anywhere from 7-15 years all the way up to 50 years.
The ‘coupon’, in bond investment terms, is the interest percentage paid back to you annually throughout over the course of the bond’s lifetime. Provided your chosen company (or government) is financially reliable, the return for bond investors can be high, with percentages often standing at around 2-5%.
