1.Income – Bonds typically pay interest semi-annually. The investor is therefore provided with regular and predetermined income. It is a contractual obligation undertaken by the issuers who has normally been rated for financial soundness by international rating agencies. 2.Portfolio Diversification – A balanced portfolio generally includes a combination of cash, equities (stocks) and bonds. It provides an investor with appropriate levels of income, safety, flexibility and opportunity. 3.Capital Appreciation – Under certain circumstances, namely when interest rates are expected to fall, bonds can provide investors with an opportunity for capital gains. 4.Preservation of Capital – Although the day to day value of a bond will fluctuate according to market conditions, bonds ultimately mature at par value. Therefore, an investor knows the exact amount to be received at maturity. However, if capital is required prior to maturity, interim fluctuations will form an important consideration. 5.Guarantee on Full Par Value – The par value of the bond is guaranteed and paid by the issuer at maturity. 6.Predictability – The regular interest payments provide investors with predictability in their portfolios. 7.Liquidity – If funds are needed before the maturity date, bonds can be sold through an investment dealer. The price received upon sale of the security will, of course, depend on the prevailing level of interest rates.
HOW TO MAKE PROFITS IN THE BOND MARKET?
Taking advantage of interest rate moves may provide opportunities to generate profits in the bond market. If an investor believes that interest rates will fall, purchasing longer-term bonds is a prudent strategy. Locking into a high yield (the price of the bond is at its lowest) and selling the security in a lower interest environment (the price of the bond is at its highest), could provide the investor with capital gains – which is normally not taxable.
This also reflects the fact that bond prices move in the opposite direction to bond yields.
RISKS AFFECTING BOND PRICES
Although a bond is considered a conservative investment, there are a number of risks associated with fixed income investing. These include:
1.Interest Rate Risk – As previously discussed, the movement of interest rates could have an adverse effect on bond prices. In some instances losses may be created. 2.Purchasing Power Risk – inflation erodes the purchasing power of a fixed income security and hence becomes an important factor investors should consider.
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