Investors can buy bonds from brokers, banks, or directly from certain issuers. You can buy newly issued corporate, municipal, and agency bonds or bonds trading in the secondary market through your broker or from certain banks. In the secondary market, you buy bonds that are being sold at some point after issue by a previous investor.
You can also buy US Treasury issues through these intermediaries or buy them directly in a regularly scheduled Treasury auction with no intermediary and no commission.
How does Bond trading work?
Companies and other organizations may issue bonds when they need to raise capital to support ongoing operations, fund new projects, or restructure existing debt.
The borrowing organization issues a bond that includes the terms of the loan, interest payments that will be made, and promises to pay the bond back at an agreed-upon date. The return bondholders receive for lending their money to the issuer includes the interest payment (the coupon). The coupon rate is the interest rate that determines the payment. As a result, the new stock tends to dilute, or reduce, the value of the existing stock.
What’s more, companies may raise more money through a bond offering and can deduct interest payments on their tax returns. But bonds are debts that must be repaid. Too much debt can be a significant drag on a company’s success.
Most already-issued bonds are traded over-the-counter (OTC), a term that means over the phone or by computer. Bond dealers across the country are connected via electronic display terminals that give them the latest price information. A broker buying a bond tries to find the dealer offering the best price and calls to negotiate a trade.
Brokerage firms also have inventories of bonds to sell to clients looking for bonds of particular maturities or yields. Often, investors make out better buying bonds their brokers already own – or make a market in – as opposed to bonds the brokers have to buy from another firm.
How are Bonds priced?
The market sets bond prices according to the specifics of each bond. The set price of the bond is par value (also known as face value). Additionally, it represents the sum the investor will receive at maturity. Bonds can be bought or sold at par, at a discount (below their face value), or a premium (above their face value).
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The price of a bond changes nearly every day, just like any other publicly traded security; the more demand there is for bonds, the lower the yield. Therefore, bond prices rise in response to increased demand. However, the interest payment to the bondholder is fixed; it was decided when the bond was first issued. So, despite having paid more for the bond, secondary market bond buyers get the same interest.
The price of a bond changes in response to changes in interest rates in the economy. Bond prices decline when interest rates rise to equalize the bond’s interest rate with market rates and vice versa.
One way to understand the bond’s price is to add a zero to the price quoted in the market. The bond is trading at a premium if it is trading at 101. In other words, it costs $1,010 for every $1,000 of face value. The bond trades at par if its price is 100 or $1,000 for every $1,000 of its face value. A bond trades at a discount if its market quote is 99, which equals $990 for every $1,000 of face value.
The Treasury bill auction process
The Bureau of the Fiscal Service handles transactions in new Treasury issues. To buy, you establish a TreasuryDirect account, which keeps electronic records of your transactions and pays interest directly into your bank account. You can find the forms you need on the TreasuryDirect website to enroll online. You can sell your Treasury securities before maturity, but if they’re in a TreasuryDirect account, you must move them to a brokerage account. This may not make financial sense with small balances or relatively short maturity times.
The Treasury bill auction process
T-bills offered on Thursday for Monday sale
The US Treasury offers 13-, 26- and 52-week T-bills for auction every Monday.
- Across the country, institutional investors (such as pension funds and mutual funds) who want to buy the major part of the issue ready their competitive bids. Their bids must arrive at the Treasury by
- 1:00 p.m. on Monday, the auction deadline. Bidders state the rate they are willing to accept on the bills. At the same time, individual investors can submit non-competitive tenders, or offers, through TreasuryDirect. Investors decide how much they want to put into T-bills, and authorize a debit to cover that amount.
1 pm Deadline for all bids
- The Treasury accepts bids, from the lowest to the highest rate, until the quota is filled.
1:10 – 1:15 Results announced
- Within minutes, the Treasury announces the auction results, and bidders learn what the auction rate is and the price they will pay to buy the bills.
- All the competitive bidders who bid rates lower than the cutoff bid have their orders filled at the auction rate. However, any institution whose bid is at the cutoff, or auction rate, may not be able to invest as much as it had wanted if the quota has already been filled.
- Individuals and small institutions that have submitted non-competitive bids get the auction rate that’s been determined by the competitive auction. They can invest as much as they wish, up to $5 million in an individual purchase.
- A non-competitive bidder’s transaction is completed when the amount due for the purchase is debited from the bank account linked to his or her TreasuryDirect account.
- At maturity, par value is credited to that account, or $100 for each bill. If the purchase price was $99 per bill, the $1 per bill difference is the interest. At maturity, noncompetitive bidders can roll over their T-bill investment in their TreasuryDirect at the new auction rate, or they can opt for redemption at par value.
What Bonds to buy?
High minimum investment requirements can make it hard for individuals to invest in most bonds. Even though par value is usually $1,000, bonds are often sold in minimum lots of five or more and may require an investment of at least $10,000. US Treasurys are the exception since you can purchase just one bill, note, or bond at a time if you wish. As a result, institutional investors, such as banks or mutual funds, hold most individual bonds, particularly corporate bonds. In addition, many high-net-worth individual investors hold substantial numbers of munis.
An alternative is buying bonds through an actively managed account, or a portfolio of individual bonds chosen and overseen by a professional investment manager. Of course, you’re just one of the hundreds of investors whose accounts are managed by the same manager. But while all the accounts will include many of the same bonds, you can customize your account to some extent in collaboration with your investment adviser and the professional manager.
Other investors may choose bond funds rather than bonds. A bond fund makes it easier to diversify a fixed-income portfolio and allows you to reinvest your earnings to buy more shares. But funds don’t promise the return of principal at a set maturity date or pay a fixed interest rate. In one sense, buying a bond fund is making an equity investment in debt securities, as you own shares of the fund that owns bonds.
Is buying Bonds a good idea?
Bonds are a good investment choice for income investors because they frequently provide a consistent cash flow. Owning bonds can be a component of an investor’s balanced portfolio strategy because they are less volatile and more stable than stocks. The diversification that bonds add to your portfolio may be the main advantage of investing in bonds. In addition, when the stock market is falling, they can assist equity investors in protecting their capital.
It would be best if you acted responsibly when making any bond-related investments. Consider researching potential issuers, comparing bond ratings, and, if possible, talking to an investment professional to get their advice.
The type of bonds that might be right for you depend on several factors, including your risk tolerance, income requirements, and tax situation. A reasonable bond allocation might include different types of bonds, such as Treasury Bonds, Corporate Bonds, Municipal Bonds, and Agency Bonds. Your choice of bond type will frequently affect how you buy and sell bonds.
Depending on the organization that issued the bond, you may or may not have to pay taxes on the interest income (coupons) from a bond or the dividends from a bond fund. Some municipal bonds offer tax-free coupon income for investors. On the other hand, you typically have to pay federal and state income taxes on the interest you receive from corporate and mortgage-backed bonds. You are only needed to pay federal income tax on the interest you receive from Treasury and agency bonds that are guaranteed by the “full faith and credit” of the United States government.
All You Need To Know About Buying And Selling Bonds by Inna Rosputnia
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