Buying Bonds now?

[bobg]

Hi Guys,

I'm totally new to the stockmarket and I am beginning my education. I've been reading investopia which seems to have the basic information I need to understand concepts.

Now, I was looking at buying some government bonds, but would I be right in assuming that the value of bonds I would buy now would drop if interest rates increase....

i.e If I brought bonds now, then tried to sell them in 2 years with interest rates higher than what they are now, that I would lose out?

I know this is a newbie question and I am trying to learn more.

Cheers.

 

[drsmith]

Consider the following simplistic example.

You buy a 5 year bond yielding 5%pa. After one year you wish to sell the bond but the bond rate (now 4 year) has risen to 10%pa. The only way a 10%pa return can be achieved from a bond yielding 5% is a reduction in the capital value of the bond such that the sum of the income yield and capital growth from holding the bond to maturity equates to 10% per annum.

If you hold the bond to maturity there is no capital loss but the income from the bond is obviously less than someone who has invested later at a higher rate.

If you feel interest rates are going to rise then cash or short term fixed interest are the best interest income options.

 

[Judd]

The ASX has a bond price/yield calculator you can use at

http://www.asx.com.au/resources/calculators/bonds/price_yield.htm

If you are actually interested in the RBA's formula, on which these calculators are based, then have a read at this link but be warned, you will need to put on your slippers and get yourself a nice, hot mug of cocoa.

http://www.rba.gov.au/MarketOperations/Domestic/OperationalNotes/pricing_formulae.html

 

[bobg]

Thanks guys your assistance is very much appreciated.

 

[helicart]

You also want to keep an eye on the 30 day interbank cash futures implied yield curve.

and the big 4 forecast bond yields amongst other stuff.
westpac
anz

 

[bobg]

Thanks mate,

I must admit a lot of this is still going over my head... I have a lot more research to do still.

Cheers.

 

[helicart]

Try this resource....it is one of the best for explaining the basics.
Investopedia - Bond Basics

And confirming what drsmith said above:

- bonds are highly liquid in that they can be bought and sold before their maturity date.

- people won't invest in bonds unless the return (interest paid and final repayment of the bond face value) is as good as putting it in the bank or other low risk investments.

- therefore, bond yields follow the overnight interbank cash rate

- for the yield to go up, the value of the bond has to go down, and vice versa.

- so the interbank cash rate is inversely correlated to the price of bonds. when the rate is high, bond prices have downwards pressure applied.

- however bonds roll up into maturity every month, according to their maturity date.....and a bond closer to maturity won't be as sensitive to the cash rate as one that is further from maturity.

Why? It is all about the % return expected from all cash flows associated with the bond i.e. all interest paid over the remaining period and the final payout (fixed face value).


Finally, I'd encourage you to continue with a concerted study of the bond market. Stocks, funds, and commodities are not as reliable as bonds for predicting where the smart money flows, ergo what the future holds. Traders of bonds deal with massive amounts of capital for governments, sovereign wealth and pension funds, and very wealthy sophisticated investors.....Bond traders are the cream of the crop as far as analysts and traders go. They have access to much better research than your average equity fund or stock analyst.

Following the bond market will reveal where the smart money is going, and give insight into many country's economic outlook.

 

[bobg]

Once again, Thank you for your very informative response.

I am currenlty looking into Hybrid securities as an option. I'm still getting my head around the terminology, but at the moment they seem like a 'relatively' safe investment and return higher than I would get just leaving it in the bank.

I have found this two articles ( one postsed somewhere on this site already) rather informative and interesting.

http://thebull.com.au/articles_detail.php?id=2114

http://www.investopedia.com/articles/bonds/08/bond-market-basics.asp

Once again. All of your help is very much appreciated.