By Samuel Taube
Transcript:
Samuel Taube: Joining us today is Steve McDonald, The Oxford Club’s Bond Strategist, and we are talking about the basics of bond investing today. Steve, thanks for joining us.
Steve McDonald: It’s my pleasure, Sam. Thank you for having me.
ST: So, when we’re talking about bonds, we usually mention two numbers: price and yield. Now, in basic terms, what do these two numbers actually represent? How are their values determined?
SM: One of the biggest misunderstandings about bonds is that bonds fluctuate in value – not as much as stocks do, but their market value will fluctuate based on fundamentals for corporates and interest rates for government bonds and municipal bonds. So the price is simply whatever price you pay for a bond at any given time.
Now when a bond is issued, it’s always at a thousand dollars. It can instantly trade down a little bit, but it’s usually $1,000 per bond. And we’ll work with that number of $1,000. The coupon is the second variable in this.
A coupon, unlike any other number in investing, is cast in stone. If you buy up a bond and you pay $1,000 for it, and it has a 7% coupon, that coupon cannot change. And that means for 7%, you get $70 a year.
So on your $1,000 investment, you get $70 a year, no matter what happens, short of a bankruptcy. The only way that can change is if the company or the government defaults or goes into bankruptcy.
ST: Right.
SM: Now, this is where people get confused, and I’ve never understood it because it works exactly the same way with dividend stocks. If the market price of a bond drops from a thousand dollars to, say, $90, the percentage that you get in income, which is called the current yield, actually goes up, but it doesn’t change.
ST: Right, it has to be that $70 number, right?
SM: Yeah. But that $70 remains the same. So essentially, if you buy a bond for $900 and you get $70, you get a higher percentage than if you paid $1,000 for it, and the reverse is true.
If you paid [$1,110], you’re getting a lower percentage, but you still get the $70. It’s really pretty simple. But at the root of this problem, Sam, isn’t the numbers. The numbers are easy. Anybody can understand that. The problem, though, is that information in the money press and media about bonds is awful. I mean, it’s almost nonexistent. That’s the real problem.
ST: I see. Now, this next question might be a bit of a lengthy one, so if you just want to summarize, that’s fine.
SM: Okay.
ST: What is the basic difference between how investors treat a government bond versus a corporate bond or a municipal bond? How do their risks and returns differ?
SM: That’s a great question. In fact, I just did a little conversation about that in an article recently. Let’s start at the top. Government bonds, Treasurys, notes, bills and bonds. They’re absolutely guaranteed. But again, we’re back to …read more
Source:: Investment You
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