Tips on Buying Bonds in the US
Standard & Poor/Moddy's Rating Systems, Accrued Interest & Insurance
To buy a bond intelligently you'll need to understand Standard & Poor/Moody's Rating Systems, accrued Interest and insured bonds as well as other factors related to cost.
Before proceeding into the bond market you'll need to know bond rating systems, such as that of Standard and Poor's or Moody's rating systems, accrued interest, maturity dates call dates, and insured bonds. Rating systems are vital to any bond for they relate to you how creditworthy the issuing entity is in terms of being able to repay the loan or bond back to you.
Any one of the two mentioned above are accurate in the way they rate. You will find that bonds are rated by both or by either one. When rated by both you'll rarely see any differences in their ratings for the same bond. Bonds are rated as AAA or AA+ which denotes the highest rating that one could give to an issuing entitiy, downwards to CCC or less. Bonds in this lower spectrum are speculative, usually refered to as junk bonds. These issuing entities are either near bankruptcy or are nearly insolvent. In general stay away from bonds rated below A.
Accrued Interest
Accrued interest refers to the interest that is accumulating on a bond that hasn't been purchased yet. When you buy a bond, not only do you pay the par price for it, but you'll need to purchase the accumulated interest on that bond as well. This interest, although purchased, will get refunded back to you on your next interest payment date plus any additional interest that accumulates from the time you purchase the bond.
As an example, you buy 10 bonds of ABC at 100 par giving 5% interest. The ABC bond gives interest in March and September. You buy this bond in December. So, for arguments sake, you will pay $10,000 for the 10 bonds, plus $125 for the accrued interest that has accumulated since its last interest due date back in September. So the total cost to you is $10125.
When the next interest payment date arrives in March you'll get not only the $125 dollars that you paid in December, but an additional $125 that you made holding the bond from December to March, for a total of $250. Interest gets paid twice a year. 5% of $10000 is $500 per year dividied by 2 semiannual payments of $250 per payment.
Maturity and Call Dates
The maturity date tells you the latest date the bond needs to be payed back. Bonds, depending on their type, can range from a month to upwards of 30 years. The longer the bond takes to mature, the riskier the bond will be, due to it being subject to varying interest rates.
Call dates give the issuing entity an option to pay the bond back earlier. This is important because if an issuer decides to pay the loan back sooner, it can affect your overall yield. Usually a call to yield rate is listed with each bond. This allows you to see what the differences are with this yield in relation to the yield to maturity number. You must factor this in to your decision-making process when buying bonds, so as not to overpay for a bond that could potentially give you less in the long run, compared to other comprable products.
All call dates have a par number written. Sometimes issuers will compensate you for the "inconvenience" of a call, so to speak. This means that ABC has the right to pay back the loan entirely instead of its maturity date. However, they will pay $10200 for every $10000 you hold, giving you more than face value. In general, if interest rates go below what you are currently recieving by way of bond interest, expect a company to call the bond. If interest rates are higher than what you are recieving, it's a safe bet that the company will want to keep the lower interest rates and not call the bond.
Guaranteed Payment
Bonds, in general, aren't insured. Usually insured bonds are seen in the municipal bond market. Although no municipality has actually defaulted on its bonds, some have come close. As a result, many have insured themselves in case of default, promoting a sense of confidence in the investing public. It's OK to invest in these, but by sticking to AAA or AA rated bonds, you'll still come out fine.
