How Bonds Trade
Why should bonds be any different?
Most people buy bonds intending to hold onto them for a while so they can get their annual interest payments. But that's not all that bonds are good for. You can also sell them or trade them. In some cases you can even—presto change-o—transform them into stocks.
How to Buy
If you want to buy a bond, you're going to have to do some homework first:
- Check out the bond rating with Standard and Poor's or Moody's (like at school, the more As the better).
- Check out the company or government offering the bond to see whether they're in good financial shape or close to bankruptcy (and therefore likely leave you holding the bag).
- Find out how much debt the bond issuer has.
- Compare bonds by price, interest rate, and other factors.
- Consider how far up the list of seniority you are on this bond (will this bond get paid first or dead last?).
Once you're ready to buy you can go through a bank or broker. You can also buy government bonds through TreasuryDirect. Schwab, E*Trade, and all the other online companies that let you buy stocks.
Reading a Bond Table
It's Bond…table bond.
Eh, that didn't work as well as we'd hoped.
Bond tables give you lots of information about bonds, so you can compare them and keep track of your own investment.
Make no mistake: only the most financially-loving person will enjoy this stuff. Bond tables are essentially columns of numbers and letters; reading them is about exciting as watching roots grow in, but it's a necessary evil if you want to buy or sell bonds.
Bond tables vary, but basically, each row relates to one bond and each column has some information about that bond, like…
- Bond name and/or issuer of the bond
- Maturity date (the date when the issuer will pay back the principal to bondholders)
- Coupon (the interest rate)
- Bid price (the amount people are willing to pay for the bond, always expressed as a percent or a number out of 100)
- Yield (usually the Yield to Maturity, or the annual return)
- Change (the difference in the bond price from the last time the bond table was listed)
- Volume (the number of bonds traded in the past day)
Not all columns will be included, but most bond tables will at least have four columns of information.
Having fun yet?
If you thought you were taken for a ride with commissions on stock buys, wait until you check out bonds.
Bond commissions can be even more confusing if you buy from a bond broker. Brokers usually link commission and cost to the price of the bond. For example, if a broker purchased a $2,000 bond with an 8% interest rate, he or she might then turn around and sell it for $2,250.
The difference between the asking price and the amount the broker got/paid for the bond is the commission of sorts—and it cuts into how much you're making from the bond. If you paid $90 to the broker, that's $90 less you're making on the investment. The good news: if you're really rich and investing a lot, you may get a cut on the commission because the broker will want your business.
If you buy bonds as part of a fund, you're probably paying fees and commissions, too, and these can affect how profitable your fund is. If you're using a broker or any financial service to buy and sell bonds, read the fine print (no matter how boring) to figure out how much you're paying.
The Mechanics of Bonds
To understand how buying and trading bonds works, you need to understand how bonds themselves work. Let's say Lady Gaga launches a corporation and needs $100 million to buy a new purple wig factory. She decides she'll pay the whole amount back by 2020. She could just go to a bank to get a loan—or she could issue bonds.
She'd probably hire some financial peeps to tell her what interest rate she'd need to charge to get people to invest. Those folks might tell her that investors would demand 8% in interest. That 8% is the coupon rate, and she could go ahead and issue $100 million in bonds. Each investor could buy the bonds in $1,000 chunks, since Lady Gaga decides that's the par value for each bond. So one bond is $1,000, and if you invested in one of them, you'd get $80 per year every year until 2020. That year, you'd get your $1000 investment back.
Until 2020 rolls around, though, that bond becomes an asset you can sell or trade. Like any asset, it can increase or drop in value depending on a bunch of factors (demand for wigs, how well Lady Gaga is doing financially, and how many people want to buy her bonds). You paid $1,000 for the bond, but the actual, current value will go up and down.
You'll still get your $80 per year, though. Unless Lady Gaga goes bankrupt, which…yeah, we're not worried.
Deciding to Sell
You have two options with bonds: hang onto 'em until they mature and get all those interest payments on them…or sell them.
There's always that moment when you wonder whether you should a sell a bond. Maybe you really need the money. Maybe the market changes and you don't think bonds are the way to go right now.
Should you stay? Or should you sell?
Only you can make the choice, but you'll want to think carefully. It costs money to sell your bonds if you're using a broker for the deal. On the other hand, if interest rates have dropped or the company linked to your bond is doing well, the bonds may be worth more than you paid for them. In that case, you may make a profit by selling your bonds now and you'll still get to keep the interest you've made so far on the bond.
Another reason to sell is if you have bonds that can be easily converted into stocks and you decide that that's a better option. If you have these types of convertible bonds, you may have fewer costs associated with making the switch, and you can take advantage of the company's growth.
Whether you're buying, selling, or just gloating over your bonds, bonds are a great addition to your investment strategy. With today's online accounts, buying and selling bonds is as easy as buying a new toothbrush on Amazon. Unlike your toothbrush, though, bonds are going to be in your life for a while, so you'll want to make sure you're making the right decisions.