Key considerations when investing in bonds

THERE are a number of issues to consider when investing in bonds. These issues include but are not limited to: the issuer’s status, bond’s maturity, redemption features, credit quality, interest rate, price, yield and tax status.

All factors collectively determine the degree to which the bond fulfils one’s financial objectives.

Interest rate

The interest rate is a stated annual rate of interest that an issuer pays on the principal to the holder of the debt security.

The interest rate is either fixed or floating though in certain instances there is no interest rate to consider.

It all depends on the underlying characteristics / features of the instrument. Consequently, an investor can receive interest payments either monthly, quarterly, semi-annually, at maturity or none at all. The most common periodic payments are either quarterly or semi-annually.

Most debt securities carry an interest rate that stays fixed until maturity. The interest rate is a percentage of the initial investment amount. Once fixed, the interest rate allows the borrower and creditor to accurately predict their respective future cash flows.

Some sellers and buyers of debt securities however prefer having an interest rate that is adjustable thereby closely floating in line with the changing operating environment. A floating rate is reset periodically in line with changes in a base interest rate index.

For bonds with no periodic interest payments, the investor receives one payment at maturity. This once off payment would be equal to the principal plus the total interest earned.

Zero coupon bonds do not pay cash interest but are sold at a substantial discount to their face amount. The discount therefore translates into a profit on maturity when the bond is redeemed at its full face value.

Investors should therefore bear in mind that bond market prices are partly influenced by movements in the level of interest rates. There is an inverse relationship between bond prices and interest rates.