Questions to Ask When Preparing to Buy or Sell Bonds
After having determined your overall investment strategy and educating yourself on the basics of bond transactions, you are ready to begin seriously evaluating the purchase or sale of a bond. Following are key questions that you should consider before buying or selling bonds. It may be helpful to print this section so you can complete the shaded boxes with information from the bond issue you are considering for investment. As always, working with a financial professional may help you identify your investment goals and the instruments that will help you achieve those goals.
The bond’s maturity date is:_____
What is the Maturity of the Bond?
A bond’s maturity is the date at which the bond issuer legally agrees to repay your principal (or initial investment). You need to know what the bond’s maturity is to factor into your overall investment objectives. For example, if you need to have access to the principal you are investing within 5 years then you might not want to invest in a bond with a 10-year maturity.
This bond does/does not have a call date: _____
Does it Have Early Redemption Features Such as a Call Date?
A “call date” feature is when a bond issuer retains the right to repay, or “call” the loan earlier than the bond’s maturity date. Having a callable bond means that you may not earn as much interest on the bond investment as you had expected. Check to see if you are investing in a callable bond and consider what types of bonds you may want to think about investing in advance to offset any potential decrease in interest income if the bond is called.
The bond’s credit rating is: _____
The bond is/is not insured: _____
What is the Credit Quality? What is the Rating? Is it Insured?
A bond’s credit rating is an indicator of what the marketplace thinks of the bond issuer’s ability to repay principal and interest on a timely basis. It is very important to know if you are considering an investment grade bond or high-yield (and higher rate of risk) bond. If a bond is insured that means that there is an insurance company standing behind the offering that is guaranteeing to repay investors their principal and interest in a timely manner should the company, state or municipality issuing the bond, default. Investors can also purchase insurance on secondary market bond purchases.
The bond’s coupon is: _____
What is the Interest Rate, or Coupon, of the Bond?
What is the Price?
The stated price is how much it costs to purchase/invest in the bond issue. What is the yield to maturity? And what is the yield to call? A bond’s “yield to maturity” is the rate of return that you can expect until the bond matures, or will be repaid. The “yield to call” is the rate of return you are guaranteed until the earliest date at which the bond may be called, or repaid.
The bond’s yield to maturity is: _____
The bond’s yield to call is: _____
What is the Tax Status?
Different bonds have different tax status. For example, interest income from U.S. Treasuries is exempt from state and local taxes. Interest made on municipal bonds is free from federal income taxes, and some states will also drop state and local income taxes (in that case your interest income is “triple tax free”). The trade-off for tax breaks associated with certain bonds is that often you will get a lower interest rate than you may find with other taxable bonds. How much the tax break is worth to you depends on your income tax bracket and the state in which you live. It is always a good idea to consult an accountant and/or other financial professional before making investments that carry tax implications.
The bond’s tax status is: _____
What Will the Actual Yield be After My Broker has Taken out His/Her Commission and Fees?
However, the yield you have just calculated above does not reflect any fees charged for the transaction, or your broker’s commission, which is figured as a percent of the purchase or sale. Ask your broker what his or her commission is and what, if any fees are associated with this transaction. Click here to learn more about Investor Costs Associated with Buying and Selling Bonds (create link to Investor Costs call out in the Financial Professional article)
The bond’s yield will be: _____
My broker’s commissions and fees for this bond purchase/sale will be: _____
What is This Bond’s Credit Rating and “Directional Outlook”?
Remember that a bond’s credit rating gives you insight into the ability of the issuer to repay your investment in a timely manner. The higher the rating (AAA being the highest), the lower the risk; conversely, the lower the rating, the higher the risk of default (non-payment) by the issuer. You can learn more about a bond issuer’s creditworthiness from reading its prospectus. In the prospectus you can learn how the issuer intends to raise money to repay the investment. A bond’s directional outlook is in what direction the market forecasts the bond being perceived in the future. A bond’s outlook affects its marketability (how much investors are willing to pay for the bond in the marketplace). While the market is constantly fluctuating it can be helpful to know what the current outlook is on the bond(s) you are considering for your portfolio so that you have an idea of how the market might respond when you are ready to sell the bond.
The bond’s credit rating is: _____
The bond’s directional outlook is: _____
Are There Any Call Features or Other Unique Features on This Prospective Bond?
A call feature is a provision in the bond whereby the issuer retains the right to repay the investment before maturity. Calling the bond forces an investor to look for another investment, typically one that offers a lower interest rate.
You may want to list any features associated with this bond: _____
What is the Transaction Type for This Bond?
When you purchase, or sell a bond, you will want to know whether or not this bond is being offered to investors for the first time (a new issue) or if this is an older, existing bond (a secondary market transaction) meaning that the broker-dealer will either sell the existing bond from its own inventory or go out into the market to find the bond in which you want to invest. Newer issue bonds may be more difficult to invest in since you are competing with large institutions as well as professional investors. Secondary market transactions may carry a markup if your broker needs to go outside his/her firm’s inventory (if they carry one) to purchase the bond from another broker to resell to you.