The Federal Reserve, consistent with its dual mandate of pursuing full employment and stable prices, has been conducting aggressive monetary policy driving interest rates to historically, low levels. This action by the Fed has led to large gains in bond prices. As a result, most bonds are now actually trading at what is called a "premium" ;.Premium bonds are misunderstood by the retail investor who typically focuses their attention primarily on the dollar price of the bond rather than its yield.
Bonds are normally issued in $1,000 face value increments. An attachment selling at below face value is said to be selling at a "discount" ;.An attachment selling at its face value is said to be selling at "par", and an attachment selling for significantly more than its face value is said to be selling at a "premium" ;.Don't confuse these terms (discount, par, premium) with levels of quality or value. An attachment selling at reasonably limited does certainly not ensure it is better or for instance more expensive on a relative basis than the usual bond selling at par or a discount. Those terms are just used to spell it out the bonds current price in accordance with its face value. So, if the dollar price of an attachment really doesn't express its' relative value, how can an investor compare bonds? That answer may lie in the bond's yield. premium bonds UK invest
Yield takes into account the cost, the maturity, and the coupon rate. Yield is an exceptionally important concept in bond investing that's typically overlooked by retail investors, who make value judgments by solely focusing on the dollar price. Yield is a significant tool to gauge the return of just one bond against another [other things being equal, like credit ratings, call features, and/or the maturity date]. In essence, "yield" could be the rate of your return on your own investment. Professional dealers and traders, when buying and selling bonds together, usually quote prices in yields not dollars; yield gives you a sudden check out the relative value in comparison to other bonds. When considering yields, here are a few useful tips to search for value:
- Compare the yield of the bond you're considering to other similar investments. Bonds are not as liquid as stocks and, many times, you will find value by comparing.
- When evaluating various maturities of the exact same bond, go through the incremental yield (the spread) you'd be receiving by investing in the longer maturity and be sure you feel it's worth the excess risk. Yields are quoted in basis points: 1 basis point is 1/100th of just one percent; 100 basis points is corresponding to 1%. For instance, if you should be comparing a 15 year bond with a 30 year bond, and the 30 year bond yields only 5 basis points more, that may not be worth the excess risk.
- Higher rated bonds will usually provide a lower yield, other things being equal. If you are evaluating less rated bond, make certain the excess yield you'd get (the spread) with the low rated bond may be worth the excess risk.
- Don't get swept up in a particular maturity date. As a result of way bonds are traded, it's very possible to obtain a bond with a smaller maturity that offers less expensive, other things being equal.
- In this interest rate environment, consider investing in higher coupon bonds (Premiums) which are usually more defensive should interest rates rise prior to when anticipated. But bear in mind when interest rates remain as is or go lower for an extended time frame, bonds with call features might be redeemed prior to when everything you had anticipated.
