The bond market. You may think you haven’t heard about it. You are probably wrong. In addition to occasionally hearing about “rallies” in the bond market most Americans has heard of the $3 trillion deficit the U.S. government currently faces. What makes up this deficit? Treasury bonds. These bonds and other securities the U.S. Treasury issues help fund the activities of the U.S. Government and have an integral role in the bond market. The bond market is comprised of many different types of bonds which can greatly vary in features. Let’s explore some basic functionality.
A bond is a debt security that obligates the borrower to pay a specified amount to the investor on a given date and usually includes coupon payments.
A bond offers investors returns through appreciation and interest (coupon) payments.
A bond has many distinguishing features including par value, maturity, coupon rate, issuer, credit rating.
There is an inverse relationship between bond yield and bond price.
So we have discussed a bit about returns and rates, but there is some terminology that needs to be addressed and will make you a bit better off for knowing it. At the end of the day interest rates are pretty powerful things that shape the entire financial system, so let’s learn a little more about them. (Warning: simple math ahead so non-math types bear with me).
It has been in my learning experience that there is no one definition of the word risk. There are many variations on the concept and many ways to view it.
Risk in my opinion could best be described as “uncertainty of results due to the inherent unpredictable nature of the future”. To put risk differently if you had psychic powers and could accurately see what the future held you would have no risk in your life as there would be no uncertainty to outcomes.
Risk is the chance that your expectations concerning a return are not what actually occurs
There is a fundamental relationship between risk and return of an investment
Let’s begin with a pretty basic idea and define what an investment is. You have probably heard “John bought Apple stock years ago that turned out to be a great investment” or “by earning a college degree I am investing in myself.”
An investment in its simplest terms is a purchasing of an asset in with relative certainty that the asset you purchase will generate income and/or increase in value. Another way of looking at an investment is that you are sacrificing immediate consumption in hopes of a greater payoff at some point in the future. Let’s go through some examples to paint a clearer picture.
An investment is an asset that will either increase in value and/or generate income.
Returns are how we measure how “good” or “bad” an investment is.