Blog: Spirit of Money, Financial Fluidity
by munificent

Yep, Bonds are gonna Suck

Yes, and this is no new news =whenever inflation raises interest rates bonds become discounted...Say you bought a CD- and 5 days later you could purchase another CD and it pays more interest for the same $1000 face price- which would you pick- Yes ofcourse the one that paid more interest- That's why the older bond sells for less than the $1,000 face value. But if you hold the older, lesser interest paying (whoa too many words!) bond to maturity date-you will get your interest and your $1,000 investment ....If you trade bonds- this is when you get dinged! Gee its been along time since I had to explain this concept! Simply put, there is an inverse ratio of face value of a bond in a raising interest rate environment

Date:   10/28/2005 9:31:18 PM   ( 16 y ) ... viewed 1186 times

Bad News Bonds

Bondholders reportedly face a conflicting set of fears. One is that the Fed's new leadership will be soft on inflation, hurting fixed-coupon returns. The other is that it will hike interest rates sharply, sending the prices of existing bonds down.

Stephen Taub,
October 28, 2005

With the overall bond market suffering scads of bad news, these aren't the best of times for companies to float commercial paper.

Rising interest rates have knocked down prices in the secondary market. At the same time, bondholders are plagued by a competing set of fears about the future, according to a story in the Wall Street Journal.

One fear is that the Fed's new leadership will be soft on inflation, hurting bond values and making them less alluring by eventually eroding the value of fixed-coupon returns, according to the story. On the other hand, some existing bondholders reportedly fear the Fed will become more aggressive in fighting inflation by sharply hiking interest rates. And whenever interest rates go up, the price of existing bonds invariably falls.

Meanwhile, the bad news generated by large issuers like Ford Motor and General Motor has dampened investor appetite. GM, for instance, recently announced it received subpoenas from the Securities and Exchange Commission about its accounting practices. "When the market trades off on old news, it's a negative-sentiment indicator," Tom Murphy, head of investment-grade corporate bonds at RiverSource Investments in Minneapolis, told the Journal.

Indeed, Ford Motor Credit’s $1 billion offering on Wednesday saw only moderate demand, even though it came with what the newspaper called generous terms.

Another source of concern among bondholders is the increased activity among leveraged buyout funds. LBOs typically add debt, according to the story. That could hurt the value of bonds in the secondary market. Further, stock buybacks, dividend payouts, and other equity moves that favor shareholders also may involve large amounts of debt that typically erode bond values, the Journal reported.

Many companies are also borrowing money to buy back their stock, a move that tends to dampen bond prices. All of those developments have led to a continued flight to quality—and away from commercial paper—as investors seek the relatively safer haven of Treasuries.

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