The Federal Reserve, commensurate with its dual mandate of pursuing full employment and stable prices, has been conducting aggressive monetary policy driving interest rates to historically, low levels. This action by the Fed has resulted in large gains in bond prices. Therefore, most bonds are now actually trading at what is called a "premium" ;.Premium bonds are misunderstood by the retail investor who typically focuses their attention primarily on the dollar price of the bond in place of its yield.
Bonds are normally issued in $1,000 face value increments. A connection selling at below face value is said to be selling at a "discount" ;.A connection selling at its face value is said to be selling at "par", and an attachment selling for more than its face value is said to be selling at a "premium" ;.Do not confuse these terms (discount, par, premium) with degrees of quality or value. A connection selling at reduced does definitely not make it better or for that matter more expensive on a family member basis than the usual bond selling at par or perhaps a discount. Those terms are just used to spell it out the bonds current price in accordance with its face value. So, if the dollar price of an attachment really doesn't express its' relative value, how do an investor compare bonds? That answer may lie in the bond's yield. premium bonds to invest
Yield takes under consideration the purchase price, the maturity, and the coupon rate. Yield is an incredibly important concept in bond investing that's typically overlooked by retail investors, who make value judgments by solely emphasizing the dollar price. Yield is an essential tool to assess the return of one bond against another [other things being equal, like credit ratings, call features, and/or the maturity date]. In essence, "yield" could be the rate of one's return on your investment. Professional dealers and traders, when buying and selling bonds together, usually quote prices in yields not dollars; yield provides you with an immediate research the relative value in comparison to other bonds. When taking a look at yields, here are a few useful tips to search for value:
- Compare the yield of the bond you are considering to other similar investments. Bonds are not as liquid as stocks and, many times, you'll find value by comparing.
- When evaluating various maturities of the same bond, look at the incremental yield (the spread) you would be receiving by purchasing the longer maturity and make sure you feel it's worth the excess risk. Yields are quoted in basis points: 1 basis point is 1/100th of one percent; 100 basis points is equal to 1%. For example, if you are comparing a 15 year bond with a 30 year bond, and the 30 year bond yields only 5 basis points more, that is typically not worth the excess risk.
- Higher rated bonds will usually give you a lower yield, other things being equal. If you should be evaluating less rated bond, make sure the excess yield you would get (the spread) with the reduced rated bond is worth the excess risk.
- Don't get trapped in a particular maturity date. Due to the way bonds are traded, it's very possible to obtain a bond with a shorter maturity that offers better value, other things being equal.
- In this interest rate environment, consider purchasing higher coupon bonds (Premiums) which are generally more defensive should interest rates rise sooner than anticipated. But remember when interest rates remain as is or go lower for an extended time frame, bonds with call features may be redeemed sooner than everything you had anticipated.
