Page 51
Bonds are considered as safe or low risk investments relative to other
types of securities, as bondholders are generally positioned at the top of
the priority list with other creditors, to be paid off ahead of others (such
as stockholders) should the bond issuer face bankruptcy. Therefore
while the upside gain on bonds maybe limited or lower than other types
of investment, the potential loss on bond investment is by the same
token lower than that of others as well. Bonds are generally issued with
maturity lengths of 1 to 40 years.
Bonds are usually sold to the public through trustees (e.g., banks or
trust companies) appointed by the issuers. A trustee, representing the
bondholders, oversees the fulfillment of the contract or agreement
between the bond issuer and the bondholders. The contract or loan
agreement under which the bonds are issued is known as the indenture.
The indenture includes the rights of the issuer and the bondholders,
principal repayment, rate of interest, collateral specifications, and
default handling procedures, among other clauses.
Bond Yields
The way the rate of return on bonds is quantified is by using their
yield (also known as effective interest), which is proportional to the
interest rates associated with them.We already covered the relationship
between interest rate and yield, but for the sake of clarity we will engage
in a short discussion of bond yields here. Bonds are usually sold in
$1,000 units (some are offered in $5,000 units) with a stipulated interest
rate determined by several factors such as demand, risk of default, rate
of inflation, and interest rates on other bonds. Another factor in
determining a bond’s interest rate is its time to maturity. Bonds with
longer maturity dates generally pay higher interest than those with
shorter ones. (This doesn’t always hold true. For example, sometimes
the 10-year Treasury note’s yield may end up higher than that of the 30- …
|