BOND EVALUATION: PROJECT DELIVERABLE 2
U.S Treasury bond market: The 10-year Treasury note
As stated above, the 10-year Treasury note is basically a debt obligation which is mainly issued by the government of the United States. Although it matures after 10 years, it usually pays a fixed rate of interest once every 6 months with a face value to the holder after the end of 10 years (F.I, 2016). This is to imply that the main advantage that comes from investing in the 10-years Treasury note as well as other national government is that there is the exemption of the interest payment from the state and the local income tax (F.I, 2016).
Moreover, it is true that it has been outperforming other indexes. The reason for this is because the since it is one of the government bonds, it remains to be the security issued by the central government dominated in the state’s own currency (Investopedia, 2014). On the other hand, since they are typically auctioned, it is termed as being risk-free. This is to mean that government can easily devaluate their currency or just opt to raise taxes for the need of redeeming the bond at maturity. In the long-run, the yield to be required by investors so as to be in the position of loaning funds to the government will reflect inflation expectations as well as the likelihood that such a debt will be repaid (Y.F, 2016).
Conversely, as much as the bonds are the interest bearing security, it then means that it will force the issuer to pay its holder a specified sum of money especially at specified intervals. The reason for this is because always the bond market is perceived as being volatile or unpredictable thus making them to bear the interest rate risks (Investopedia, 2015). In the long-run, in case there is the increase in the rate of interest, there will be a corresponding decreases in bond prices and vice versa. Such effect ends up becoming more pronounced for all the long-term securities. In the similar way, fixed income securities, carry various risks for instance inflation, default and credit risks for the counterparts and the issuers themselves.
Nonetheless, some non-investment or high yield grade securities mostly entail not only price unpredictability but also risk default as compared to the investment grade bonds. As a result of this, fixed income securities which will be redeemed or sold before it matures may be subjected to loss. In the long-run, asset allocation and diversification does not guarantee or ensure profit against loss. At the end, what will be noted is that in case credit spreads gives a good impression of the credit risks associated with it compared to another security that will not be the only factor to be represented (Market Realist, 2014).
After buying a corporate bond, what it means is that the holder has the capacity of benefiting from the declining interest rates as well as from the narrowing of its credit spread. This in the long-run will contribute to the lessening returns to maturity of the newly issued bonds. In return this is what drives up the price of the bondholder. In other words, since rising interest rates as well as widening of the credit spread, there is the need of evaluating its outcome first. Consequently, since narrowing of its spread provides less ongoing yield and since its widening will hurt the bond price, it is important for investors be wary of them without abnormally narrowing credit spreads (Investopedia, 2014). This is to imply that, in case the risks mentioned above are to be acceptable, the high credit spreads will offer a prospect which narrows that spread thus creating a price appreciation.
In addition to that, the interest rates of this bond usually don’t change gradually because of the uncertainty in the bond market. This makes the investors to park their cash in the super-safe U.S. Treasuries thus causing its outcome to drop as well as its price to rise considerably. During this period, it is expected that higher returns from high yield bonds will be the one which will assist on compensating for the increased risk hence making its return to rise as well as the prices to drop significantly (F.I, 2016). With this, it means that even if the treasury returns are declining, the credit spreading for the high-yield bond will be getting wider. The suggestion from this is that the credit spreading has the capacity of giving investors an idea on how cheap or expensive the bond market for a certain bond category will be.
The bottom line of this is that in case the extra returns ends up becoming more and more affordable, its investors will be bothered with both its future credit spread and interest rates. Additionally, as much as the bond market is concerned, the credit spread might remain to be constant or narrow down. Since the width of the credit spread is perceived to be the main determiner of the bond price, it is essential to ensure that evaluation have been made so as to determine whether such a spread is too narrow (Market Realist, 2014). The companies with wider credit spread should also be taken into consideration.
Reference
Fidelity Investment (2016). Investment grade bond funds. Retrieved from https://www.fidelity.com/fund-screener/evaluator.shtml#!&ft=TBND_GI%2CTBND_GL%2CTBND_GS%2CTBND_IP%2CTBND_CI%2CTBND_CL%2CTBND_CS%2CTBND_UB&ntf=Y&expand=%24FundType
Fidelity Investments (2016). How high and how fast? Retrieved from https://www.fidelity.com: https://www.fidelity.com/viewpoints/investing-ideas/bond-market-outlook-2016
Fidelity Investments. (2016). New life for money markes. Retrieved from:
https://www.fidelity.com/viewpoints/investing-ideas/money-market-investing
Yahoo Finance. (2016). Bond ticker.Retrieved from http://finance.yahoo.com/bonds/market_summary/article/200001/bond_ticker
Investopedia (2014). What causes bond prices to rise? Retrieved from http://www.investopedia.com/ask/answers/111414/what-causes-bonds-price-rise.asp
By investopedia (2015). How safe are high yield bonds? Retrieved from http://www.investopedia.com/ask/answers/070615/how-safe-are-high-yield-bonds.asp
Market Realist (2014). Credit spreads: A fixed income investor’s must-know guide. Retrieved from http://marketrealist.com/2014/03/must-know-credit-spreads-represent-credit-risk/
