Although increasingly participating in the United States bond market, foreign investors investing in United States equity and bond markets have earned lower returns over the past five years than if they had invested in the same asset classes in their own countries. And there are several reasons why they might choose to continue investing in the United States bond market.
More specifically, foreign investors choose to invest in the United States in order to benefit from the highly developed, liquid, and efficient financial markets and strong corporate governance and institutions in the United States, and to diversify risk, especially if returns in the United States financial markets have a low correlation with returns in their own country’s domestic financial markets. Investors outside the United States may also choose the United States over other countries due to their strong linkages with the United States through trade flows or other measures of closeness.
The definition of the bond is that a bond is a fixed-income instrument that represents a loan made by an investor to a borrower that is typically corporate or governmental. Bonds are meant to be used by companies, municipalities, states, and sovereign governments to finance their projects and operations. Investors who own the bonds are debt-holders or creditors of the issuer.
There are five main types of bonds, which are treasury, savings, agency, municipal, and corporate bond. Each type of bond has its own sellers, purposes, buyers, and levels of risk. An investor wishing to take advantage of bonds can either purchase bonds or securities that are based on bonds, such as bond mutual funds.
Stocks and bonds, while often lumped together, are fundamentally different from one another. Unlike stocks, bonds are not representative of a stake in a company. As a result, the return on a bond is fixed and does not have the opportunity to appreciate as stocks, for instance. Bonds function as a loan that a company or government pays back over time with interest. Considering this, bonds are less volatile when comparing to stocks or cryptocurrencies. However, bonds are not liquid and do offer less returns. While bonds are relatively safe, they do not offer impressive returns like other investment strategies. Typically, the safer the bond, the lower the interest rate of return.
Investing in bonds, particularly in the time of uncertainty, such as COVID-19 or Ukrainian crisis, or higher inflation, offers a particular advantage as they are indexed to inflation. Unlike some other investments, bonds allow investors to defer government taxes on income until they redeem them or bonds reach their maturity.
As bonds are considered to be safer investments by many investors, this leads some to argue that older investors should invest in bonds rather than stock, for instance. This argument is commonly justified in three ways: that stocks are less risky over a young person’s long investment horizon; that stocks are often necessary for young people to meet large financial obligations, like college tuition for their children; and that younger people have more years of labor income ahead with which to recover from the potential losses associated with stock ownership.
However, others may argue whether older investors should shift away from investing in stocks in the first place. To answer this question, we can attempt to use standard economic reasoning to evaluate three reasons that are offered. The only seemingly reasonable reason to encourage older investors to invest more in stocks is that as investors age, they have fewer years of labor income ahead of them. If, as is true for most people, an investor’s labor income is not directly correlated with stock returns, then our economic analysis concludes that the investor has to follow this advice, in which as time passes, they must shift more financial wealth out of stocks and into bonds.
If an investor’s labor income is highly correlated with stock returns, then our economic analysis demonstrates that the investor is likely to be better off ignoring the common advice of investing more in bonds than in stocks; instead, they should do the opposite. As an investor gets older, they should shift more financial wealth out of bonds and into stocks.
Corporate Bonds as new Issues
Investors can find it difficult to acquire newly issued corporate bonds directly from the issuer. An investor typically needs a relationship with the bank or brokerage that’s managing the primary bond offering. When considering investing in a specific corporate bond, an investor has to have a full knowledge concerning the bond’s rating, investment-grade or non-investment grade junk bonds. An investor must know most important issue related to corporate bonds such as maturity.
The maturity is usually short, medium, or long-term. Investors also need to pay attention to a number of important issues, such as interest rates, that are either fixed or floating, and how the coupon or interest payment is paid, regularly or zero-coupon. And also, to complete the purchase of a corporate bond issued for the first time, an investor needs a brokerage account that will cover his purchase price and any commissions that broker might charge on the acquisition of the bond.
For corporate bonds, investors need to perform a price comparison for bonds under consideration. For instance, he has to check and to be sure that he is comfortable with the spread a broker is charging prior to purchase.
Municipal Bonds as New Issues
Purchasing municipal bonds as new issues requires an investor to participate in an issuer’s retail order period. The investor needs a brokerage account with the financial institution backing the bond issue, and must complete a request indicating the quantity, coupon, and maturity date of the desired bonds. The coupons and maturity dates can be found in the bond prospectus, which is given to prospective investors.
We recommend that an investor who is committed to buying some individual or municipal bonds on his own, without an investment adviser, he must research and compare fair pricing for individual bonds using an online research engine, such as Electronic Municipal Market Access EMMA in the United States.
Government Bonds as New Issues
Investors can purchase government bonds, such as the United States Treasury bonds, through a broker or directly through Treasury Direct. As mentioned earlier, treasury bonds are issued in increments of 100 USD. Investors can buy new-issue government bonds through auctions several times per year by either placing a competitive or non-competitive bid. A non-competitive bid means that investors accept the terms set by the auction. When placing a competitive bid, an investor can indicate his preferred discount rate, discount margin or yield.
Investors must know that treasury bonds aren’t offered on the secondary market by the government, but they can be purchased via brokerages.
Secondary Market Bonds
In the bond market, bondholders often sell their bonds prior to reaching maturity on the secondary market. If an investor is interested, he or she can buy all the above types of the secondary bonds on the secondary market. Purchases are made via a brokerage, particularly through bond brokers or public exchanges.
When buying bonds on the secondary market, to generate higher income, an investor needs to do more research, as pricing in the secondary market is less transparent. With bond as new issues, all buyers pay the same price. However, on the secondary market, there can be a markup on corporate and municipal bonds. It’s also entirely possible to see the same bond offered by two different dealers at two different prices. An investor may also be charged commissions, transaction fees, and contract fees on bond-related transactions.