Factors That Affect the Yield on Bonds
In the financial world, a bond is a financial instrument of an issuer that promises payment of income to the bondholders on a regular basis. In fact, there are many types of bonds including corporate bonds, municipal bonds, and commercial bonds. Corporate bonds are bonds secured by the assets of a corporation. This means that if the corporation is unable to pay the amount of the bonds, then the holders of the bonds will be able to claim their loss. On the other hand, municipal bonds are bonds secured by a city, town or regional entity.
Commercial bonds are mainly used to finance companies that generate or produce perishable commodities
Therefore, such bonds must have a higher interest rate and longer maturity period to compensate for the risk involved in such enterprises. Most of these bonds are traded on stock markets. They may also be traded over the counter.
Municipal bonds are issued by municipalities such as cities, towns, villages or schools. When these bonds are issued, the name of the issuing authority is mentioned on the bond. Usually, the name of the municipality appears on the title. Sometimes, the title of the issuer and the maturity date are also mentioned.
The principal type of municipal bonds is known as the first mortgage
These are usually issued by local governments. The issue amount is less than five percent and it has a term of one year to ten years. Most of the time, they are issued by school districts. However, some cities issue them without obtaining approval from the county or state government.
The second type of municipal bonds is the discount bond
These are normally issued by financial institutions. There are some factors that determine the credit quality of an issue. These include, credit quality of lenders, maturity of the underlying assets and term of the debt. The longer duration leads to more flexibility for the debtor.
The third type of municipal bonds are corporate bonds
These are issued by corporations that own certain assets such as factories or lands. The main purpose of issuing corporate bonds is to raise funds. Corporate bonds are usually issued by publicly traded corporations such as hedge funds. They are the most risky form of bonds, with a high default risk.
The highest-rated bonds are the junk bonds
Junk bonds are issued by municipalities that are unable to raise the required funds. The purpose for issuing such bonds is to sell them at a discount. This allows bondholders to have less value in exchange for the interest rate.
The main reason why the bonds lose value over time is because of inflation and higher interest rates. As the price of a product increases, the bonds issued by the municipality have a lower interest rate. However, this situation seldom occurs because governments often have budget deficits during the downturns in the economy. The only time when it happens is when they have excessive surpluses. Governments normally increase the borrowing limit in order to cover the deficit.
The first step in determining the market price of a bond is its maturity date
The maturity date is the earliest date that the bond issuer can sell the bonds without having to worry about other investors selling the same bonds. The longer the maturity date, the lower the market price will be.
The second factor that affects bond prices is the risk factor. When the issuer wants to raise money, the probability of the company defaulting on the debt is high. To prevent this from happening, the issuer issues bonds. The lower the risk of default, the higher the market price of the bonds.
The third factor that influences the yield on bonds is the coupon rate. The coupon rate indicates the amount of interest that will be paid to the bond issuer. Higher the coupon rate, higher is the yield on the bond.
Zero-coupon bonds have coupons that are zero dollars. These bonds are issued by the Federal Reserve. They offer zero percent interest. Unlike regular bonds, they do not accumulate interest. A zero-coupon bond will earn interest only if the coupon rate is zero dollars.
What Types Of Bonds Are Issues By Governments?
In financial terms, a bond is simply a legal instrument of debt of the bond issuer to its borrowers. The most familiar form of bonds are corporate bonds and municipal bonds. Bonds may also be in individual investing wherein an individual would lend a particular company or the government a certain loan. Bonds in this category are normally secured by a specific asset that will be returned during some specified period of time. Examples of such assets are properties, stocks, commodities, and other financial assets. Usually, bonds are created to facilitate the transfer of tax-based payments between individuals and companies.
There are different kinds of government bonds available depending on the purpose for which they are intended
The two most common are municipal and corporate. To help you understand which among these two you should invest in, let us have a look at the pros and cons of both.
As the name implies, the objective of a bond is to secure the interest of bondholder when there is a dip in the open market. When a bondholder default, the borrower who has invested in the open market receives a secondary amount called the coupon or yield. The interest rates fluctuate depending on the financial crisis which has occurred and the level of fear in the market.
Governments often issue government bonds to guarantee the fiscal capacity of their governing bodies. Bondholders are often provided with low interest rates, since the risk is shared by the community. Usually, the secondary market for these bonds is the stock market since the investors are spread over a wide area. A secondary market usually has lower costs, since there are more participants. Since the costs are lower, the secondary market is considered a viable alternative for bondholders.
There are several types of pricing bonds
In the primary market, bonds are issued in response to an economic problem which causes a temporary dip in the market price of the underlying assets. In the spot market, the bonds are issued on the basis of speculations or bets. For example, when a particular asset is expected to fall, traders can buy the bonds to insure themselves against a fall in the market price of that asset.
There are many reasons why governments issue bonds
Most of them have to do with the stability of the economy. Governments normally guarantee the fiscal solvency of their respective entities so the issuing of securities is a great way to build up their credibility. Issuance of securities is also done to raise money to finance specific projects of the state. The issuers of corporate bonds typically use the equity markets as their source for issuing securities.
Typically, bondholders are secured by the fiscal soundness and liquidity of their respective local governments. The issuance of revenue bonds is meant to raise funds for projects that are intended to generate tax revenue. These projects, usually infrastructure projects, are often designed to boost the local economy through increased tax revenue and employment opportunities. The bond issuer is typically a government agency or a municipality. The amount of the tax that will be collected from the investors will depend largely on the performance of the local municipality in terms of its budget.
Municipal bonds are normally issued by states, cities or municipalities
Several states and municipalities to issue municipal bonds each year to raise money for a variety of purposes. Projects such as repairing roads, improving public utilities or acquiring property for economic development can generate substantial amounts of municipal bonds issues. The prospect of issuing municipal bonds to raise money is also attractive to companies that want to raise money for their own expansion or potential acquisition of a firm. Many private firms also issue municipal bonds for the purpose of financing their own ventures.
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