Forex Investment and Currency Trading

When you buy fixed income securities, typically bonds, you’re lending money to earn some income. The borrower might be a corporation or  a state or federal government.

Why Invest in Bonds?

Buying bonds reflects a decision to make income a higher priority than protection. How much more of a priority is still a matter of degree you can control.

1. Money is needed Here’s an example. A city may need to raise money to build, renovate, have operating money, or simply to pay off other debts. It hires an investment banker to help. The banker helps determine how much money it will need, how long it will need to repay the lenders (the investors), and the lowest interest rate it could get away paying and still attract enough interest from investors. A municipal bond offering is created, and the city is named as the municipal bond issuer.
2. Floating an offer The investment banker floats an offer to the public (tests it) to see if it can sell enough bonds at its terms to raise all the money. If it can, everything moves ahead. If it can’t, it may either reprice (determine a new interest rate and other terms) and try again, or withdraw the offering.
3. Investors buy This is where you come in. Say you and other investors decide to invest. In effect, you’re saying, “I’ll lend you money. I’m willing to accept your promise to repay my loan plus interest, by the specific date, according to the terms in your offer”. For example, you may buy several twenty-year bonds for $1,000 each. The city will be expected to pay a fixed interest rate of 6% ($60) every year, in four annual installments, for twenty years. You can sell a bond at any time and take a profit or loss, apart from any interest you have earned.
4. What if Interest Rates drop? If interest rates drop, new bond issuers will enter the market selling new bonds with lower interest rates than yours. That will make your bonds more valuable. You could decide to sell your bonds. There will probably be others willing to buy. If you do sell, you can demand a profit (called a premium) because the bond pays more than the going rate. For example, if new bonds are being issued at 4%, buyers might agree to pay you $1,090 a bond for your 6% bonds. You would earn a $90 profit on each bond, and they would replace you as the new lenders. Now it would be their turn to receive interest payments and assume the risks of lending to this particular borrower.
5. What if Interest Rates rise? If rates rise, the reverse of #4 would occur. Your 6% bonds would be less valuable because investors could do better than 6% by buying new bonds. If the going rate for newly issued bonds is 8% you may be forced to sell at a discount (for example, $920) to entice potential buyers. You would have earned the interest up to the point of selling, buy you would also take a loss of $80 on the original investment. (The bond cost $1,000. You sold it for $920. The difference is $80).
6. Maturity: The Loan Ends. After twenty years, time is up on the loan. Every owner of these bonds at this time is paid $1,000 for each one, no matter when they bought the bond or at what price. For example, the person who paid you $920 a bond would now receive $1,000, or an $80 profit per bond, in addition to the interest earned.

Think like a lender

You may be “investing” in a bond, but you should still think like someone lending money to someone else. Here’s what to consider.

The amount. Many bonds are initially sold in units of $1,000, called par value. After that, trading occurs at whatever prices the market will bear.

Issuer. This is the borrower. Check out the firm’s or agency’s reputation and the bond’s quality rating. This is the best way to gauge your chances of being fully repaid with interest.

Yield. The amount you earn, based on the price you pay for the bond.

Maturity. When the loan is due. You don’t have to stay until the end. You can sell the bonds at any time to anyone willing to take your place as the lender.

Call feature. A prepayment option. Some issuers reserve the right to call the bonds, which means they can prepay the entire loan and end it.

Duration. Duration is the term used to describe the time left until a bond matures (the loan ends). This tells you how long until the original investment is returned and you realize a gain or loss.