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Who invests in bonds?
How much to allocate to bonds?
*If held to maturity, subject to issuer credit risk.
Bond prices and yields are subject to change based upon market conditions and availability. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise.
What are bonds?
– Coupon rate (or just coupon) is the annual interest rate paid to investors as compensation for the loan. Coupon payments typically are made semiannually unless otherwise stated. For example, a 4% coupon bond will pay 2% twice a year based on the par value of the bond. Learn more about types of income.
– Maturity is the term of the bond’s life. Bonds range in maturity from three months to 100 years. On the maturity date, the bond’s face value is repaid to the investor and the interest payments stop.
– Call provisions give an issuer the option, at its discretion, to redeem bonds (pay back the principal) prior to maturity after an initial non-call period. Bonds are generally called when the situation is most beneficial for the issuer. In general, bonds are called when market interest rates fall, allowing the company to issue new bonds with lower coupon rates. To compensate investors for the reinvestment risk and unknown final term of investment, callable bonds generally offer higher yields than non-callable alternatives. Learn more about callable bonds.
– Credit rating is usually a reflection of an issuer’s ability to pay interest and principal but may not fully represent its creditworthiness. Independent rating agencies assign ratings based on their analysis of the issuer’s financial condition, economic and debt characteristics, and specific revenue sources securing the bond. Issuers with lower credit ratings generally offer investors higher yields to compensate for the additional credit risk. At times, bonds with comparable ratings may trade at different yields, which may further indicate the market’s perception of risk. A change in either the issuer’s credit rating or the market’s perception of the issuer’s business prospects will affect the value of its outstanding securities. Ratings are not a recommendation to buy, sell or hold, and may be subject to review, revision, suspension or reduction, and may be withdrawn at any time. More details about credit ratings can be found at Factors That Affect Prices of Fixed Income Securities.
Types of Taxable Bonds
U.S. Treasury Securities are issued by the United States government and generally are considered the safest of all investments because the timely payments of interest and principal are guaranteed by the U.S. government. Because of the safety advantage, government bonds pay relatively lower interest rates than other fixed income securities. Treasury bonds are issued in a wide range of maturities, from four weeks to 30 years. Generally they are non-callable, and interest payments are exempt from state and local taxes. Treasury bonds can be purchased through your financial advisor or directly from the U.S. Treasury.
Government-Sponsored Enterprise securities (GSEs) are issued by government-created corporations and most carry “AAA” ratings.
Both Fannie Mae and Freddie Mac are government-sponsored entities and operate as public companies. Although both were created by congressional charters, neither is a government agency. Timely payments of interest and principal are sole obligations of the issuers. Their securities do not constitute debt of the United States and are not guaranteed by the federal government.
Brokered certificates of deposit (CDs) are issued by financial institutions, such as banks, and are sold directly through brokerage firms like Raymond James. Brokered CDs have characteristics similar to bonds, but offer the protection of FDIC insurance, which covers up to $250,000 per issuer (including principal and interest) for deposits held in different ownership categories, including single accounts, joint accounts, trust accounts, IRAs, and certain other retirement accounts. FDIC insurance does not protect against principal losses due to sale prior to maturity. Prices of brokered CDs fluctuate during their lifetimes due to changes in interest rates. Upon maturity, CDs are redeemed at par. Consult your financial advisor for more information about the difference between regular bank CDs and brokered CDs. To learn more about brokered certificates of deposit, please read our Disclosure Document (PDF)
Corporate bonds are debt obligations issued by U.S. and foreign companies to raise capital for business growth and general corporate purposes. Most are unsecured promises to repay the principal at a predetermined future date, although some bonds may be secured by a first mortgage or other assets. Since corporate bonds are considered riskier than some other fixed income investments, such as U.S. Treasury bonds, they generally offer higher yields. Corporate bond prices are affected by changes in interest rates, issuers’ credit ratings and other factors. Please consult with your financial advisor about various bond features before investing.
Foreign currency bonds are issued by corporations and governments. In addition to offering bonds in domestic markets and local currencies, governments and companies also can issue bonds in other markets and different currencies. Foreign currency bonds carry additional risks that domestic bonds are not subject to, including currency risk, political instability and local market risk. As with any investment, foreign securities should fit within the investor’s stated objectives and risk tolerance, and should be allocated accordingly.
Preferred securities offer certain benefits of both stocks and bonds. They are most suitable for investors with a long-term time horizon who are interested in a fixed rate of return. Unlike common stocks, most preferred securities are issued with a fixed dividend or interest rate which is typically paid quarterly, and most have a par value of $25 per share. Since most preferred securities are considered debt and are senior to common stock, they enjoy a priority claim over common stock on assets of a corporation in case of a liquidation; however, they are often junior to bond holders. They generally have a much longer term maturity than bonds, and in a number of cases they are perpetual. Some preferred securities are subject to unique risks which include the fact that the issuer may defer interest payments for up to 10 years. However, the investor will be liable for income tax on accrued but unpaid “phantom income.” Further, dividend payments are not guaranteed and will only be paid if interest payments on the underlying obligations are made, which are dependent on the financial condition of the issuer. In addition, most preferred securities are callable at the option of the issuer, just like bonds, and may be subject to tax event or special event calls. The market value is sensitive to changes in interest rates. Unlike common stocks, preferred stocks do not have voting rights.
Mortgage-Backed Securities and Collateralized Mortgage Obligations
(MBS) traditionally have been referred to as relatively high quality, high cash flow generating investment vehicles. However, turmoil associated with mortgage loan originations reveals the need to understand these investments and the factors that drive their performance. Many potential investors shy away from MBS, while others consider this an opportune time to invest.
Also known as “munis,” municipal bonds are debt obligations issued by state and local governments and other governmental entities to fund the building of highways, hospitals, schools, sewer systems and many other public projects. Munis are attractive to investors in high tax brackets because, in most cases, the interest income is excluded from federal income tax calculations. If investors own municipal bonds issued within their states of residence, interest income may also be excluded from state and local taxes.
Fixed Income Advantage
Working with your Raymond James financial advisor, you have a Fixed Income Advantage, as your advisor has the freedom to offer objective, unbiased advice with access to client-focused resources. Once your advisor understands your personal circumstances, a meticulously tailored long-term plan will be based solely on your specific goals.
Income and Diversification