July 28, 2008

Bonds 101, part 6 - How to buy bonds

Bonds can be a little less straight forward to buy and sell than stocks. When shopping for bonds you can buy new issues or resold buy bonds on the market. Discount brokers deal in bonds and you can buy treasuries direct from the U.S. government.

New bond issues have a price set at the face value and interest rate at the coupon rate. The bonds will have a specified time frame given as a maturity date. So for example you might see a new issue of bonds from ABC corp. with a coupon of 6.2 and maturity of 8/1/2018. That means the bonds will pay 6.2% interest for 10 years. ABC corp. will have a credit rating from the rating companies such as Moodies. Look for the letters such as AAA, A3, BB or similar.

For resold bonds bought on the open market you are buying a bond from someone else who currently owns it but is now selling it. Bonds bought on the market have a price which is basically a % of the face value. So if the price listed is 95.45 then you are paying 95.45% of the face value. Because interest rates go up and down people are willing to pay a premium for some bonds or less than face value for other bonds. If ABC corp issued a bond this month at 6.2 and then interest rates go up significantly in the future then people won't be as willing to pay as much for the existing 6.2 rate bonds if they could instead buy other new bonds for more than 6.2 rate. Or on the other hand if interest rates go down in the future then new bonds sell with coupon of less than 6.2 then people will pay more for a bond with a higher existing coupon. Since the price varies the actual yield you get when buying a bond may differ from the coupon rate. For example if a bond is originally sold at face value with a coupon of 6 and then 3 years later interest rates have gone down then the bond might sell at a premium price of 114. Your immediate yield for that bond is 6 / 114 or 5.2. Since you are paying more than face value for the bond your actual interest return is less than the coupon rate.

Where to buy?
Corporate and municipal bonds can be bought via a broker. Charles Schwab, Fidelity, E*trade, ScottTrade all deal in bonds. The minimum purchase for bonds can be pretty high and the commission fees for the broker are not always obvious. You will pay a commission or fee for the bonds you buy. The fees are in the $30-50 range per bond purchase. Zions Direct charges $10.95 per bond purchase so they might be worth looking into (I haven't used them myself).

Treasuries are a little simpler to buy. The treasury bonds are available to purchase direct from the US government. You can open an individual account at Treasury Direct and buy the bonds there online.

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