Increasing interest rates may harm the bond strategy
At times the stock market becomes not too safe of a haven, investors usually look for more comfortable zones.
In most cases, the United States Treasury Bonds have become their comfort zone. The government assures that it will take back the bonds at the values as long as they are held to maturity.
So if you purchase $20,000.00 of Unites States Treasury Bonds, you would be able to gain back the $20,000.00 during the maturity of the bonds. You would also get interest payments two times a year.
If you aim to purchase and take the bonds to its maturity, then you must know this.
Bonds and Stocks
Many businessmen take hold of their bonds at times of difficulty at the stock market. They would then sell them when an interested investor wants to have cash that he could use at the stock market.
It became their usual strategy and this one works well since the secondary market for purchasing and selling the Treasury Bonds exists.
It is not guaranteed however that you will gain back the true value of bond if you would sell it before its maturity.
Three things you must know when you assess a bond:
1. Stated Interest rate—the interest rate used in computing interest payments for those who hold bonds.
2. Face Value—the bond’s true value and how much you will pay when you purchase a bond newly issued by the Government. It is how much you will gain when the bond reaches maturity.
3. Yield—This is the amount of interest rate computed for bonds that are sold at the secondary market and it constantly changes depending on the bond’s prices.
If you purchase and sell bonds at the secondary market, it’s not a bond issuer you are dealing with but an investor.
This is an important knowledge to gain since you might be buying a bond which does not correspond to its face value.
Interest rates that come along with a bond will pay the bond holder with same interest rate throughout the life span of the bond.
But if the bond holder chooses to sell his bond before it reaches maturity, the bond holder would then get the bond depending on the current interest rate and on how they are differentiated from the bond’s stated interest rate.
Just for example, the Treasury bond is given $20,000.00 along with a 6 percent interest rate and of which will mature after a decade. The bondholder would want to sell it after its third year. In its three years, interest rates would go up to 8 percent.
Why would people want to buy a bond that would pay 6 percent if they could buy one that pays 8?
Rule of Bond
The rule of bonds shows an indirect relationship between the interest rates and the bond prices. So if the interest rates are high, the bond prices would fall.
To attract an investor, the bondholder should decrease the bond prices so that interest rates of the bonds would equal what a businessman may get from a new one.
Interest rates of the bond are a fixed 6% but you may be able to change to price you are willing to pay for the bond.
A payment of $600 per annum must be equal to 8% payment. You would then see that face value of bond should be discounted to $7500 that the $600 payment would equal to a yield of 8%.
If the interest rates go down, one may sell her bond.