Things about Bond Trading that you need to know |
Posted: August 22, 2020 |
Given how crazy 2020 has been so far, you can forgive many traders for turning to ‘safe haven’ commodities such as gold and silver right now. Another of these conservative assets that traders seek out in times of peak volatility are bonds, which offer a long-term return with lower risk than other tradable instruments such as forex and stocks. Many newcomers to trading are scared of the prospect of investing in bonds due to a lack of knowledge about them or for fear of having their capital locked down for a lengthy period. As ever, you should do your research to determine whether bond trading is for you. In this article, we’ll take a balanced look at why trading bonds could be perfect for your strategy. What are Bonds? Imagine you run a business that needs an instant injection of finance. What do you do? You could ask the bank for a loan, of course, but you are likely to be hamstrung by sky-high interest rates that add considerably more to your repayment amount. So some company bosses instead approach private investors about setting up a bond, which is, in essence, a loan but one with typically lower interest. It is repaid either annually or bi-annually, with full settlement on the maturity date. Online brokers can also be used when selecting bonds. Always make sure you seek out the best deal as some time the fees can be steep. Things to consider when trading in bonds If you want to invest in a bond, there are several factors you need to keep in mind. All bonds have a maturity date, which is the agreed date at which the ‘loan’ is fully repaid to investors. The maturity scale of a bond can be short-term, let’s say 1-3 years, medium-term or long-term – it’s not uncommon for some bonds to mature 15 years or even further into the future. So here’s the obvious question: how soon do you want a return on your investment? The risk implicit in bonds is what happens if the company goes bust before the maturity date. There are two broad types – secured and unsecured – which dictates what happens in the case of liquidation. With a secured bond, investors are guaranteed specific assets and collateral should the company be unable to repay the fund, and that can be anything from plant and machinery to mortgages and buildings ownership. Unsecured bonds, on the other hand, don’t come with any such collateral or insurance. It’s also worth noting that different bonds have varying tax statuses. In the most part, corporate bonds are subject to tax; however, some government bonds are not – they may be lower in yield, but you won’t be stung by the taxman! Advantages and disadvantages of trading in bonds When you weigh it up, bonds are an excellent tradeable asset that can add stable income to your portfolio with a modicum of risk when compared to other instruments and commodities. There are advantages and disadvantages to trading bonds, and your personal attitude will dictate on which side of the argument you fall. Advantages:
Disadvantages: - Can take a long time to mature - Yields can decrease - Unsecured bonds could leave you out of pocket - Inversely linked to national interest rates - Risk of defaulted payments cannot be ignored
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