Bond Market

The bond market could be considered an uninteresting investment vehicle. Of course, those who say that generally don’t know the rules or strategies involved in these types of investments. The rules and nuances of these types of investments are one issue to consider. Another thing to think about is that those rules have changed over time. Following is an introduction to the basics of bond trading.

Types of Bonds in Today's Bond Market

U.S. Treasury bonds are government bonds that are issued by the United States Department of the Treasury. U.S. Treasuries are split into two types that you can purchase: Series I and Series EE.

Corporate bonds are issued by corporate entities and are considered to be “investment grade”.

High Yield bonds are considered “non-investment grade”. These bonds are also known as junk bonds.

Asset-backed securities are bonds that use assets such as auto loans, home-equity loans and credit card receivables as collateral. The list of such assets is practically unlimited. These securities are very popular for those who are investing in bonds.

Mortgage-backed securities are bonds that utilize cash flows from the interest and principal payments from residential mortgages.

Agency bonds are issued by government agencies such as Freddie Mac and Fannie Mae.

Municipal bonds, or Munis, are bonds issued by a local, city or state government or any of its agencies.

Collateralized Debt Obligations are securities that are backed by any single or several Asset-backed securities or Mortgage-backed securities, loans or bonds.

Bond Basics

Bond Glossary

Security Types

Credit Crisis

Expected Returns and Benchmarks for Investing in Bonds

Spot rates and yield-to-maturity are the two measures that are used to understand the different bond market pricing conventions. By definition, a bond’s yield is the measurement that is used to determine or estimate the return you can expect from a bond.

The spot rate calculation is figured by finding the discount rate or interest rate that makes the current value of an accrual bond, also known as a zero-coupon bond, the same as its price. In order to correctly price an accrual bond, several spot rates must be calculated.

Yield-to-maturity is determined by finding the discount rate or interest rate that will make the total of accrued interest and cash flow’s equal to the present value of the bond. There are two assumptions in bond trading that this type of calculation takes into consideration. The first is that the holder of the bond will keep it until it matures. The second is that the cash flows from the bond can be re-invested.

Another part of the bond value equation is benchmarks. Simply put, benchmarks are used to price bonds, but to complicate matters, each type of bond uses a different benchmark. Common benchmarks for the bond market, in, for example, corporate bonds, are generally the most current series of U.S. Treasury Bonds.

It’s important to remember that there are risks inherent to any type of investing. Bond investing and bond trading are no different. It can be complicated and hard to understand, even for the most seasoned professional. Utilize the information provided above to make your decisions after you’ve done more substantial research.