Bonds:
How to buy Bonds
There are several ways to invest in bonds. You can buy individual bonds, bond
funds or unit investment trusts. Generally most bond transactions can be done
through a full service or discount brokerage. You can also open an account with
a bond broker, but be warned that most bond brokers require a minimum initial
deposit of $5,000.
Some financial institutions (banks) also allow their clients to purchase
government securities. If you do not have a brokerage account and your bank
doesn't provide this service you can purchase government bonds through a
government agency. In the U.S. you can
buy government bonds directly from the U.S. Bureau of the Public Debt by phone
(800-943-6864) or online at
publicdebt.treas.gov.
If you buy bonds on their web site you can pay by credit card or with a bank
debit card.
Buying Individual bonds:
The easiest way to buy a newly issued Treasury bill, note or bond is by phone or
over the internet. If you want to sell your Treasury securities before they
mature you can use the Treasury Direct "Sell Direct" service. When you buy
treasuries, you are required to fill out a tender, or bid, for the bill, note or
bond you're buying. You can submit what are known as noncompetitive bids,
which means you'll get the average interest rate produced by the auction. If you
choose to buy treasuries buy mail, your envelope must be postmarked no later
than the day before the auction and received by the date the security is issued.
You can pay by check (for T-bills it must be a certified check). Under the
Treasury Direct system, your interest and principal payments are directly
deposited into your bank or money market account. You can also pay a broker or
bank to buy and sell treasuries for you with a transaction fee.
There is an enormous variety of individual bonds to choose from. Some corporate
bonds are listed on the New York Stock Exchange (NYSE) but most bonds are bought
and sold in the over-the-counter (OTC) market. You can choose to buy either new
bond issue or buy or sell bonds which have already been issued in a secondary
market. Bonds are usually sold in $5,000 and are quoted as if the bond is traded
in $100 increments. Thus, a bond quoted at 90 refers to a bond that is priced at
$90 per $100 of face value, or at a 10% discount.
If you do decide to purchase a bond
through your broker, they may try to tell you that the trade is commission free.
Don't be fooled because because bond prices normally include a markup, this
markup is really the same as commission. To make sure that you are not being
taken advantage of simply look up the latest quote for the bond and determine
whether the markup is acceptable. Each broker or dealer establishes its own
prices, which may vary depending upon the size of the transaction, the type of
bond you are purchasing and the amount of service the firm provides. Just
remember to research your bond just as you would for a stock, there are several
factors that need to be considered before loaning your money to a government or
company, so do your homework!
Investing through Bond Funds:
Bond
mutual funds offer you another way to invest in bonds. Bond funds, like other
kinds of mutual funds offer professional selection and management of a portfolio
of securities. Unlike individual bonds, bond funds have no fixed maturity date
and no guaranteed interest rate. Nor do they promise to return your principal.
Their appeal is that you can usually invest a much smaller amount of money
(usually between $1,000 and $2,500) and allow you to diversify risks across a
broad range of issues than you would need to buy a portfolio of bonds on your
own. You also have the option of having interest payments either reinvested or
distributed periodically. One disadvantage of investing in bond fund is they
charge annual management fees averaging around 1% and some also charges sale
fees for buying and selling shares.
There is a great variety of bond funds, each with a specific investment
strategy. For example, some funds invest in long-term, and others in short-term,
bonds. Some buy government bonds, while others buy corporate bonds or municipal
bonds. Finally, some buy investment-grade bonds, while others focus on
high-yield bonds. In other words, you could buy a long-term, investment-grade
municipal bond fund, a short-term, high-yield corporate bond fund-or almost any
other combination. You can buy bond mutual funds from your broker or directly
from mutual fund companies such as Vanguard.
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What is
a Money Market Fund?
Money market mutual funds invest in stable, short-term debt
securities, such as commercial paper, government bonds, and
certificates of deposit (CDs), and try to maintain the value of
each share in the fund at $1. Most funds offer check-writing
privileges that do not trigger gains or losses, as writing a check
against the value of a stock or bond fund would.
Tax-free money market funds invest in short-term municipal bonds
and other tax-exempt debt. With a single-state fund, investors who
reside in the state that issues the bonds the fund buys can enjoy
triple tax-free earnings, which means they owe no local, state, or
federal income tax on their interest earnings. While taxable funds
offer a slightly higher yield than tax-free funds, you must pay
income tax on all earnings distributions.
Unlike bank money market accounts, money market funds are not
insured by the Federal Deposit Insurance Corporation (FDIC).
However, since they are considered securities at most brokerage
firms, they may be insured by the Securities Investor Protection
Corporation (SIPC) against the bankruptcy of the firm. In
addition, some funds offer private insurance comparable to FDIC
coverage. |
Unit investment Trusts (UITs):
Bond unit investment trusts are as much a part of the financial landscape as
individual stocks and bonds. They offer a fixed portfolio of investments in
government, municipal, mortgage backed or corporate bonds which are
professionally selected and remain constant throughout the life of the trust. .
There are also unit trusts that invest in equities. Examples of them include the
DIAMONDs Trust (DIA), which mirrors the composition of the Dow Jones Industrial
Average (DJIA), and Standard & Poor's Depositary Receipts (SPDR), which mirrors
the Standard & Poor's 500-stock Index (S&P 500).
UITs resemble mutual funds in the sense that they offer the opportunity to
diversify your portfolio without having to purchase a number of separate
securities. You buy units, rather than shares, of the trust, usually through a
broker. However, UITs trade more like stocks than mutual funds in the sense that
you sell in the secondary market rather than redeeming your holding by selling
your units back to the issuing fund. Further, the price of a UIT fluctuates
constantly throughout the trading day, just as the price of an individual stock
does, rather than being repriced only once a day, after the close of trading. As
a result some UITs (though not index-based UITs such as DIAMONDS or SPDRs) trade
at prices higher or lower than their net asset value (NAV). Index UITs are
sometimes described as exchange traded funds.
A tax-exempt unit trust is a specialized investment company that assembles a
fixed portfolio of state and local government bonds, commonly called municipal
bonds, and then sells fractional, undivided interests in that portfolio to the
public. In return, investors receive interest income on a regular basis, paid
monthly, quarterly or semiannually, depending on the trust.
The interest income on the trust remains fixed until maturity or early
redemption of securities in the trust. Tax-exempt unit
trusts are offered in a range of maturities, typically from five years to 30
years. The minimum initial investment in a tax-exempt unit investment trust is
typically $1,000.
Securities included in a tax-exempt unit investment trust are carefully selected
by investment professionals at the sponsoring firm. Bonds are typically chosen
with the intent that they'll be held until maturity. However, under certain
circumstances the bonds may be called or redeemed or sold, and investors will
receive their pro rata share of the principal.
You may sell your units at any time, according to terms explained in the
prospectus. A prospectus is a legal document that provides detailed information
about the trust. By law, your broker is required to provide you with a copy of
the prospectus.
As with all fixed-income investments, the market value of the unit trust will
vary with changing interest rates, increasing as rates decline, decreasing as
rates rise. So if you sell before maturity, you may receive more or less than
your initial investment.
Next==>>
Key terms and concepts of Bonds
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