More than one way to skin a cat

Sunday, May 19, 2019

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Have you ever heard the saying “There is more than one way to skin a cat”? Simply put, this means that there is more than one way of achieving an aim. People invest in bonds to make money, but did you know there is more than one way to make money from bonds?

If you have been reading our articles you will know by now what a bond is but for those who are new to our articles, when a government or company needs to borrow money, one of the ways it can do so is to offer bonds. Investors like you buy those bonds thereby “loaning” the organisation the money it needs. In return, the bond issuer agrees to repay the investor the principal that he or she invested plus interest.

So, in its most basic form, bonds have a fixed interest rate or coupon rate that doesn't change; the holder receives interest payments based on the coupon rate throughout the life of a bond, and on the bond's maturity date you get back the principal also known as the face value.

COLLECT INTEREST INCOME

There are two ways to make money by investing in bonds. The first is to hold those bonds until their maturity date and collect the interest payments. For example, you buy US$10,000 face value of a 10-year Government bond with a coupon rate of four per cent.

If you hold the bond until it matures you will get four per cent in interest every year which amounts to US$400 a year. Most bonds pay twice a year, and so, technically, you would receive two cheques for US$200 each. Your return will be US$4,000 over 10 years and you get back the US$10,000 face value.

The coupon rate is determined by the general level of interest rates at the time the bond is being issued, the maturity of the bond, and the credit rating of the issuer. The coupon interest you can get in the current market might be anywhere from two to eight per cent per year, depending on the bond.

GENERATE CAPITAL GAINS

The second way to make money investing in bonds is by taking advantage of capital gains. In the investment world bonds are considered the less exciting cousins of stocks. This is because many people don't realise that bonds can be traded just like stocks.

Buying a bond and holding it to maturity, the “buy-and-hold” technique, is the simplest way to make money from bonds, but you can also make money by selling your bond before it matures.

Bonds fluctuate in price similar to any other security. If the price of your bond goes up and you decide to sell it, you will get more than you paid for it, and you will also keep the interest you have made up until the time you sell it.

A profit that results from a sale of a capital asset, such as a bond, where the sale price exceeds the purchase price, is known as a capital gain.

It is important to note that although the price of your bond has gone up, you have not made a gain unless you sell at that price. Similarly, if the price goes down you have not made a loss unless you decide to sell the bond. Therefore, price fluctuations don't affect people using the buy and hold strategy as they don't intend to sell their bond. Those types of investors can basically ignore price changes unless those changes signal a deterioration in the credit dynamics of the issuer of the bond, in which case you may need to reassess your strategy.

The truth is, bonds might never leave you breathless with excitement, but they are a reliable source of income and if you trade the bond you can make even further gains thereby adding some spice to your bond investing.

Toni-Ann Neita-Elliott is the AVP, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm


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