The way our world today works, money has become a necessity. The statement “Money can’t buy happiness”, is although very subjective and varies from person to person, no longer seems to be true for most people. Which is also justified in how more and more people are majoring in Financial Studies, and if they are not taking education, you will find many who are very keen to learn the basics. One way to help one self financially, is purchase of bond. If I were to ask you, which is the hottest market in the world, you are likely to say “New York Stock Exchange”, but in truth, it is the New York’s treasury market. Again, bonds can range from Goverment to Corporate, but let us talk of them as they are, at least for the time being.
For the starters, Bond is a certificate with a face value and a coupon rate on it. When you buy a bond, you pay a certain price, which is the market price and it gives you coupons until maturity, and at time of maturity you are paid the principle amount(face value). First off, an invester should be aware of the concept of time value of money, which says that a $100 5 years from now, is worth alot less than a $100 today. How? Try putting a $100 in a fixed deposit account which pays interest, and see the money you have after 5 years. Put another way, see if you can buy the same number of pizzas from $100 today, then from a $100 5 years from now. Either way you look at it, money looses it’s value over time, and that, remains unchanged, throughout our financial studies, pursuits and activities. One easy to way to calculate the value of a bond is apply the formula of Present Value of Annuities + Present value of principle amount paid at time of maturity. If this amount is worth more than the same formula applied on a Bank Deposit, that pays interest, then you should purchase the bond.
That is as far as valuing the bond goes. However, there are alot of risks involved, when purchasing a bond. Ignoring the technical terms, let us understand them as they are. The risk of interest rate fluctuating, which depends on how economy does as a whole, the money supply in the market etc, which also justifies why when interest rates rise, the price of bonds always, always, shoots down. Another risk is the lack of confirmation, that the corporate organization can payback the amount or not. The variation in timing of coupon receipts as another thing to worry about, as the more they are delayed, the more they loose their value. So all of these risks, make it very difficult to choose which bond to buy.
On top of all this, there are rating companies that rate a bond. AAA AA BB CC DD are some types of ratings. As the name themselves suggest, AAA is a type of Bond which is sure to pay back, BB is less likely and you can follow the trails, to see how it will end at DD. This also means that market price of a AAA is righteously higher than that of a AA or BB. But, it is not as simple as it may seem, that is, not everyone just jumps in and invests in a AAA or AA bond. The reason is, a BB type bond, which is relatively inexpensive, is often a bond of a well known company and buyers are confiden that the business is not going to go bank rupt and so many people invest in various categories, normally staying with in A and B alphabets.
Generally, Goverment Bonds, are much likely to be paid back, because everyone knows that a Goverment is not going to go bankrupt, atleast less likely than a business. However, the same opportunity comes with a higher price and often lower coupon payments. In any case, there are alot of aspects that need to tested before one puts their money in a bond, time value of money, being of the key concepts as well as the patience and long term approach because Bonds are usually long term loans, e.g one decade(although they use to have 30 year bonds long ago, which have been abolished now).