Capital market: investing in bonds

efore closing on February 15th, the bond market was quiet— meaning there was no transactions recorded. At the close of business, treasury bonds worth Frw35.4 million were on offer at prices between Frw102.00 and Frw102.25 but no buyers showed up. Christine O. Asaba explains how to invest in bonds

efore closing on February 15th, the bond market was quiet— meaning there was no transactions recorded. At the close of business, treasury bonds worth Frw35.4 million were on offer at prices between Frw102.00 and Frw102.25 but no buyers showed up. Christine O. Asaba explains how to invest in bonds

Bonds are any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity instrument of another enterprise.

One may wonder what a financial asset is, or a financial liability is! A financial asset is any asset that is; cash, a contractual right to receive cash or another financial asset from another enterprise, a contractual right to exchange financial instruments with another enterprise under conditions that are potentially favourable; or an equity instrument of another enterprise. While a financial liability, refers to a liability that is a contractual obligation: to deliver cash or another financial asset to another enterprise; or to exchange financial instruments with another enterprise under conditions that are potentially unfavourable.

When the going gets tough, the tough get gambling! You must hence be vigilant in businesses otherwise someone somewhere will grab the chances from you. From your brokers advise, or from your own initiatives, you now decide to become a bond investor, you may have a series of decisions on what bonds to buy, how best to buy them, how long you want to hold them in your portfolio and when you might think about selling bonds. The more challenging issue now will be how to account for the type of bond in your books of accounts. I mean the presentation, recognition and measurement, and then disclosures, thus refer to financial reporting standards IAS32, 39 and IFRS7 respectively. These are real challenging issues, but do not worry, there are professionals for that.

For an ordinary investor, you will nonetheless involve a professional in such challenging businesses, these are brokers, refer to my previous article and qualified accountants. How to choose an appropriate professional therefore, will be the next question, do not be troubled, we will have time to discuss that in the near future.

Strategies of investing in bonds

The way you invest in bonds for the short-term or the long-term depends on your investment goals and time frames, then your risk appetite, meaning the amount of risk you are willing and able to take for a given investment.

When considering a bond investment strategy, remember the importance of diversification. It is wise not to put all your eggs in one basket, thus, it’s never a good idea to put all your assets and all your risk in a single asset class or investment. You will want to diversify the risks within your bond investments by creating a portfolio of several bonds, each with different characteristics.

Choosing bonds from different issuers protects you from the possibility that any one issuer will be unable to meet its obligations to pay interest and principal. Choosing bonds of different types (government, agency, corporate, municipal, etc.) creates protection from the possibility of losses in any particular market sector. Choosing bonds of different maturities helps you manage risk.

Interest

If keeping your money intact and earning interest is your goal, consider a "buy and hold" strategy. When you invest in a bond and hold it to maturity, you will get interest payments, usually twice a year, and receive the face value of the bond at maturity. If the bond you choose is selling at a premium because its coupon is higher than the prevailing interest rates, keep in mind that the amount you receive at maturity will be less than the amount you pay for the bond.

When you buy and hold, you need not be too concerned about the impact of interest rates on a bond’s price or market value. If interest rates rise, and the market value of your bond falls, you will not feel any effect unless you change your strategy and try to sell the bond. Holding on to the bond means you will not be able to invest that principal at the higher market rates, however.

If the bond you choose is callable, you have taken the risk of having your principal returned to you before maturity. Bonds are typically "called," or redeemed early by their issuer, when interest rates are falling, which means you will be forced to invest your returned principal at lower prevailing rates.

When investing to buy and hold, be sure to consider:

The coupon interest rate of the bond (multiplies this by the par or face value of the bond to determine the amount of your annual interest payments); the yield-to-maturity or yield-to-call, higher yields can mean higher risks; The credit quality of the issuer, a bond with a lower credit rating might offer a higher yield, but it also carries a greater risk that the issuer will not be able to keep its promises.

Look for further strategies in bond investment for the next issue.

sebasore@yahoo.com

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