Risks Associated with Buying Bonds

Bonds are, by comparison to others, a secure investment.  There are, of course, some that have greater bond risk than others. Foreign bonds contain some of the highest risk depending on the sovereign entity one buying a bond from.

Apart from Moody’s rating system, there are other ways to determine bond risk

  • Stability of the bonds currency
  • Government stability
  • Current events, both global and domestic.

The currency of a bond is a factor that makes a bond more or less risky. The rate of return for domestic bonds tends to be on the current market return.  For bonds, some of which mature after decades, there is the risk of inflation diminishing the worth.  All bonds carry the risk of a loss of principal when interest rates rise.

One can also look at the current events to simulate the risk of a government bond.  Instability of the government can make the bond less appealing, and make it a riskier investment.  Take for example how on May 24, 2010 Spain seized a “troubled regional bank.”  This instability creates uncertainty and a lack of trust in the government’s ability to repay debts.  Being part of the European Union (EU), this affects all of its members, and makes uncertainty arise across all of its members.  Unlike the American government, which can print more money if there is trouble paying the owed bond, the government cannot print more money, since it is not just their currency.

Another recent event that could show a bond being more risk than one would expect would be the labor strike in Greece, along with its international rescue loans worth $140 billion. Bailouts of this kind cause trust to dissolve in the government.  Though the fear of a government in established governments is next to nothing, the fear of power change and policy shifts could do the same as far as impact on ones investment is concerned.

To sum up, the bonds of today harbor some risk, as any investment does.  Even in the stability of the United States, there is concern of inflation rising reducing bond worth.

An Overview of Foreign Bonds

The global market has shrank as technology has developed, making everything more interdependent.  In today’s economy, people should be aware of the events and opportunities with a view broader than that of national borders. One investment one should consider is buying foreign bonds of sovereign nations.

Foreign bonds are issued in a domestic market by a foreign entity, and are evaluated in the domestic market’s currency. Because these bonds are in a different nation with different rules, the risk is far greater than that of domestic investments.  Foreign bonds are known to offer potentially higher yields than US bonds, For example, the Chinese Bonds recently offered, “…three-year bills with a yield of 2.75 percent.”

Benefits of Foreign Bonds

Investing in a foreign market can offer much more return, as they have different regulation guidelines, a different point of the business cycle, and varying standards.  One would need to go through an insurance company, a broker or a bank to invest in such bonds, as well as convert currency to the one the bonds are sold in.  Many markets have promise for growth and development that allows for a greater return, but also greater risk.

Foreign Bond Risk

Foreign bonds carry a higher risk than domestic bonds.  Risks of international bonds are higher because of, “…varying stages of economic and political development, differing regulatory environments, trading days, and accounting standards.”  The reasons the bonds have more risk are also the reason for the greater return offered, so it is an inherent tradeoff of these bonds.

There are problems associated with the purchasing of non-dollar bonds.  One problem is that “the fund will not usually attempt to cushion the impact of foreign currency fluctuations on the dollar,” and thus is sensitive to the dollar.  So any fluctuation in the foreign currency before it is transferred back to American dollars, or any fluctuation in the dollar before it is transferred back, adds additional risk.

Buying Foreign Bonds

For someone to purchase these foreign bonds, one would have to go through an investing firm.  From online searches, T. Rowe Price offers the sale of and information for foreign bonds, as well as many other investment options ().  Anyone interested in more information on foreign bonds and purchasing them can easily find a site online.

How to Buy Government Bonds

The government bond funds are an investment like any other bond.  Government Bonds from the U.S. are considered to be some of the safest bonds you can buy.  Not all governments are as reliable and secure in repaying their debts, but for most cases, buying government bonds tend to be the safest bond investment.

Purchase Government Bonds

If you are interested in purchasing U.S. bonds, you can do so through brokers and banks, or directly through the Federal Reserve Banks.

To purchase a treasury bond, one pays the initial price can be at, higher or lower than the face value of a bond.  After purchasing, a government bond will pay interest every six months until they mature. The bond also has a set maturity time up to 30 years, after which, the buyer is paid the bonds face value.

These bonds are issued to help in financially supporting the federal government, and as such will be sold by the government so long as they need more money. There are even new inflation-indexed bonds (I-bonds) which are there to help protect the purchaser from the effects of inflation.  While the profit is minimal and the investment period is long, this is still a good investment.  It is ideal for those who are content with safe, small returns, but want to ensure a return regardless of inflation.

Drawbacks of Government Bonds

The same points that offer security to investors diminish the investors profit for government bonds.  The high level of security in the government bonds make them offer moderate returns, since there is very little risk.  One can use the purchase of such bonds to diversify a portfolio and minimize risk.

Another drawback is the longer time it takes for the bond to mature.  The principal cannot be regained until the bond is retired at its maturity, which can be up to 30 years down the line unless the bond is resold.  Such a trade of bonds would still require a transaction fee for the broker or a bank, and cost some portion of the money that they would otherwise receive if they had been patient and held the bond until maturity.