Bond Basics II

Bond Basics 11

Jul 18, 2022

My previous article, Bond Basics I, covered several bonds-related concepts, including Face Value, Coupon Rate, Callability, Yield-to-Maturity, and Credit Rating. However, there is still a lot more an investor should know to better understand the seemingly complex world of bonds. Today, we review a few more concepts to help you understand the bond market and better guide your investment decisions.

The Price/Yield Relationship is an important concept for you to understand. Price and yield move in opposite directions, meaning that when bond prices rise, yields fall, and when the price falls, yields rise. The logic here is supply and demand and can be explained in a simple example. Consider you hold bonds with a 4% yield. If the current market interest rate increases to 5%. As a buyer, you would prefer to buy the new 5% bonds instead of 4% bonds as they provide you with better interest returns. The lower demand would drive the price of 4% bonds lower. Now, assume the opposite scenario. You hold 4% bonds, and new bonds come out with a 3% yield. More investors would look to buy the 4% bonds, driving the price higher.

Yield-to-call is the overall interest return that a bondholder receives when the bonds are held till their call date. It is only applicable on callable bonds that allow bond issuers to repurchase them earlier than the maturity date. The issuers usually predetermined the call date and prices, allowing the investor to calculate their expected return easily. It is important to speak with your investment advisor to understand your yield-to-call, as bond issuers will generally call bonds when interest rates in markets are low. This helps you to be prepared in advance as you are already aware of the returns you would earn in such a scenario. It is similar to yield-to-maturity, with the only difference being the option to call bonds before maturity.

Taxation on interest earned by bondholders in Jamaica is 25%. Certain bonds issued by the Government of Jamaica are exempt from tax. Understanding the taxation of bonds is important, as it helps you to calculate the post-tax returns on bonds and compare returns with your other investments.

Finally, we explore the types of bonds: Government Bonds, Corporate Bonds, and Perpetual Bonds. Government bonds are securities that a nation's government issues to satisfy its financial needs. Corporate bonds are bonds that businesses issue to meet their financing requirements. While generally providing higher returns than government bonds, these bonds typically carry a higher level of risk. Perpetual Bonds are bonds with no maturity date.

Once investors understand these terms, they can become more confident in investing in bonds and, of course, never be afraid to ask questions. A licensed financial advisor should be able to explain these basic bond terms to you before investing.

Anna-Joy Tibby is the Assistant Vice-President, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

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