How to rate bond issues and interest rates

In simple terms, the investment markets can be divided into two types: equity and debt. Equity investing is the purchase of stock in a company and represents a fractional ownership of the company. Shareholders may or may not receive annual dividends. Debt investments, on the other hand, represent a loan to the company with a corresponding return plus expected interest. A bondholder is entitled to periodic interest payments. Debt investing is considered a little safer than stocks, but every investment comes with risks.

Debt investments are commonly known as bonds. Bonds can be issued by federal, state and local governments as well as by corporations. There are pros and cons to both. For example, if you invest in a federal bond, the interest income you receive from that investment is generally not taxable at state and local levels. Likewise, interest income on state and local bond issues is generally not taxed at the federal level. Interest income from corporate bonds is taxed everywhere.

It’s a good idea to research interest rates before investing in debt securities. In the United States, the Federal Reserve Bank (or the “Fed”) sets interest rates. They do this at a meeting every six to eight weeks where the national economy is evaluated. You then decide what to do with the interest. This decision is based on many factors, but above all on the inflation rate experienced.

If inflation rises, the Fed can raise interest rates. This makes the supply of money (in the form of credit) somewhat scarcer and more difficult to obtain, which in turn slows down inflation. If there is no or very little inflation, interest rates are likely to remain as they are. When deflation or a slowing economy occurs, the Fed can try to stimulate it by lowering interest rates, which allows more people to borrow and thus stimulates the economy.

The reason you need to know what’s happening with interest rates before investing in bond issues is because bond prices are directly related to the interest rates currently available. In general, when interest rates rise, bond prices fall and vice versa. Of course, that means next to nothing if you intend to hold the bond to maturity. This is only worth noting if, like most bond investors, you tend to hold it short and sell it before maturity. So if you sell a bond before maturity during a period of rising interest rates, the value of the bond may be lower than when you bought it.

The key features of a bond issue you need to know are:

Coupon Rate – This is the interest rate that will be paid to you on this loan. You should also know when it is paid. This is usually the case once or twice a year on fixed dates.

Due Date – This is the date when the loan becomes due and payable. On this date, the company will pay back the capital you lent it.

Notice periods – Some bonds give the borrower the right to prepay the loan proceeds. Some cannot be called. Those that are callable are usually repaid at a higher price than you originally paid if the early option is exercised. Note that when a bond is callable and interest rates fall, the company often finds it financially advisable to buy back your bond with proceeds from a new bond issue at the new lower interest rates.

The greatest risk of investing in bonds is that the issuer will go out of business. That’s why Bunds are so popular; A bankruptcy of the federal government is practically impossible! Federal treasury bills are among the safest investments you can make. Corporate bonds, however, are a different story. Any company can go out of business for a number of reasons. In this case, if you have invested in a company’s bonds, your investment will be worthless almost immediately. However, bondholders have priority over shareholders and get paid first. Senior bondholders can even claim physical assets upon the company’s liquidation.

Bonds are a good, relatively safe investment as long as you consider these risk factors. A good mix of corporate, federal and municipal bonds is recommended. Even tossing some junk bonds with high interest rates could be profitable. Diversification reduces risk, also on the bond market.