The Federal Reserve, commensurate 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 such, most bonds are actually trading at what's referred to 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.
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 relationship selling for significantly more than its face value is reported to be selling at a "premium" ;.Don't confuse these terms (discount, par, premium) with examples of quality or value. A connection selling at reasonably limited does definitely not ensure it is better or for that matter more expensive on a member of family basis than a bond selling at par or even a discount. Those terms are just used to explain the bonds current price relative to its face value. premium bonds to invest in the UK So, if the dollar price of a relationship really doesn't express its' relative value, how do an investor compare bonds? That answer may lie in the bond's yield.
Yield takes into account the price, the maturity, and the coupon rate. Yield is an incredibly important concept in bond investing that is typically overlooked by retail investors, who make value judgments by solely emphasizing the dollar price. Yield is a significant tool to measure the return of just one bond against another [other things being equal, like credit ratings, call features, and/or the maturity date]. Basically, "yield" may be 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 compared to other bonds. When looking at yields, here are some useful tips to look for value:
- Compare the yield of the bond you're considering to other similar investments. Bonds aren't as liquid as stocks and, many times, you'll find value by comparing.
- When evaluating various maturities of the exact same bond, look at the incremental yield (the spread) you'd be receiving by investing in the longer maturity and ensure you feel it's worth the excess risk. Yields are quoted in basis points: 1 basis point is 1/100th of just one percent; 100 basis points is corresponding to 1%. As an example, if you should be comparing a 15 year bond with a 30 year bond, and the 30 year bond yields only 5 basis points more, that may not be worth the excess risk.
- Higher rated bonds will often provide a lower yield, other activities being equal. If you should be evaluating a lesser rated bond, make certain the excess yield you'd get (the spread) with the low rated bond may be worth the excess risk.
- Don't get trapped in a specific maturity date. Due to the way bonds are traded, it's very possible to obtain a bond with a shorter maturity that provides better value, other activities being equal.
- In this interest rate environment, consider investing in higher coupon bonds (Premiums) which are usually more defensive should interest rates rise earlier than anticipated. But bear in mind that if interest rates remain as is or go lower for an extended time frame, bonds with call features might be redeemed earlier than that which you had anticipated.
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