Hello, Tigers!
Welcome to the "US Treasuries Investment Courses." Bonds as an investment option are typically lower risk and offer relatively stable dividend payouts compared to stocks. Bonds may be a good choice for investors who are looking for long-term, stable investments and want to earn "passive income."
Those courses will focus on US treasuries and expand into other types of bond investments, exploring the characteristics, risks, and relationships between different types of bonds and returns.
Not only does bond investing provide a relatively low-risk investment option, but it also offers the potential for portfolio diversification and hedging against market volatility. So, I'm going to go into more detail for you in the next four lessons.
Ⅰ. What is a bond?
A bond is a financial instrument typically issued by countries, governments, corporations, or other entities to raise funds for various projects or daily operations.
Simply put, the issuer of a bond borrows money from an investor, promising to pay a fixed interest rate before maturity and to repay the entire principal at maturity. In order to reassure the investor, the issuer will provide a "white slip", which is actually a bond.
To illustrate with a real-life example:
Imagine a friend borrows $1,000 from me and promises to repay it in 5 years. Over these 5 years, my friend pays me $50 in interest every year and provides a note. This note is equivalent to purchasing a 5-year bond.
Once you understand the basics of bonds, you need to be familiar with five key elements:
1. Face Value: The face value of a bond is the amount the issuer returns to the investor at maturity. Regardless of whether you purchase it above or below the face value, you will receive the face value amount upon maturity. For example, a bond with a face value of $100, whether bought at $105 or $95, will still yield $100 at maturity. (The bond's face value determines the return at maturity.)
2. Bond Price: The price at which you buy a bond determines the final yield. For instance, purchasing a $100 face value bond for $95, without any interest, means you will receive $100 at maturity, resulting in a $5 ($100 - $95) profit.
3. Maturity Date: The maturity date is the date on which the bond reaches its term. After the bond matures, the issuer repays the debt at face value, or you can sell the bond before maturity.
4. Coupon Rate: The coupon is the interest paid to investors by the issuer every six months or yearly before the bond matures. The coupon divided by the bond's face value is the bond's coupon rate, also known as the nominal interest rate.
In simple terms, the coupon is the interest regularly paid to investors according to a schedule. Usually, bond coupons are paid every six months, with equal amounts each time. For example, a $100 face value bond with a 5% coupon rate means the issuer pays investors $5 in interest each year, with $2.5 every six months.
5. Yield to Maturity (YTM): This is the return a bondholder will receive when holding the bond until maturity, calculated by annualizing the average yield. For example, if you bought a 3-year, $100 face value non-interest-bearing bond for $95, your YTM and annual YTM would be as follows:
Total YTM: (100 - 95) / 95 = 5.26%
Annual YTM: (1 + 5.26%)^(1/3) - 1 = 1.72%
As you can see from the formula, the lower the bond price, the higher the yield to maturity. In other words, bond prices and yields to maturity move in opposite directions.
Ⅱ. Three major bonds categories
Next, let's move on to the classification of bonds. Generally, bonds can be categorized into treasuries, municipal bonds, and corporate bonds, as distinguished by the issuer.
1. Treasuries
Treasuries are bonds issued by sovereign nations, usually secured by the nation's creditworthiness, also known as sovereign bonds, with a very low risk of default.
Among them, US treasuries are widely regarded as an extremely safe investment option, and governments, institutional investment subs, and individual investors will regard US treasuries as a safe haven. Especially in times of economic instability or crisis, investors tend to put their money into the US treasury market, which is seen as a safe-haven option.
Treasuries are usually characterized by the following points:
(1) Extremely low credit risk: US treasuries are usually considered to be the lowest-risk investment because bonds issued by the US government are of good credit and have almost no default risk.
(2) Fixed interest rate: US treasuries usually have a fixed interest rate, and investors know the future interest payments at the time of purchase.
(3) High liquidity: The US treasury market is very active and easy to buy and sell, so it is highly liquid.
2. Municipal Bonds
The issuer of municipal bonds is the local government or the financing platform of the local government, and these bonds use the credit of the local government as the main source of repayment to provide investors with certain returns. Municipal bonds are usually used for financing infrastructure construction, public facilities construction and other public welfare projects, and are one of the main ways for local governments to raise funds.
Municipal bonds are usually characterized by the following two points:
(1) Interest is usually tax-exempt: U.S. municipal bonds usually enjoy federal income tax exemption to attract investors, especially those who reside in the corresponding local government jurisdictions.
(2) Interest rates vary by region: Municipal bond interest rates and credit ratings may vary from region to region, and therefore risk and return may also vary.
3. Corporate Bonds
Corporate bonds, also called corporate bonds, are bonds issued by a company. Investors holding such bonds are actually lending money to the company and getting a certificate of borrowing. The main purpose of a company issuing bonds is to raise funds. These funds can be used for a variety of purposes, such as expanding production, developing new products, or repaying other debts.
Corporate bonds are usually characterized by the following two points:
(1) Diversity: The corporate bond market includes a variety of different types of bonds with different credit ratings and interest rates to meet the needs of different investors.
(2) Risk varies from company to company: credit risk varies from company to company, so investors need to assess the risk based on the credit rating of the company.
I've mentioned one term several times: credit rating. What does it mean?
In essence, a credit rating is used to assess whether the bond issuer has the capability to repay both the principal and interest on time. After all, no one wants to deal with a "deadbeat." Thus, a credit rating is a significant indicator for deciding whether to purchase a particular bond.
In the United States, major rating agencies include Standard & Poor's (S&P), Moody's, and Fitch Ratings, among others.
To differentiate credit ratings, they are mainly categorized into two classes: Investment Grade and Non-Investment Grade.
Investment Grade ratings usually range from "AAA" (or equivalent) to "Baa" (or equivalent). Investment Grade bonds generally have lower credit risks, which results in relatively lower interest rates. Due to their low-risk characteristics, they attract numerous investors, including pension funds and insurance companies.
Non-Investment Grade ratings typically range from "Ba" (or equivalent) to "D" (default). Non-Investment Grade bonds are often referred to as high-yield bonds (or junk bonds) since they usually offer higher interest rates but come with higher credit risks. These bonds are more susceptible to default risks but also attract investors seeking higher returns.
At this point, I believe you have gained a preliminary understanding of US bonds. In the next lesson, I will provide you with a detailed explanation of the advantages and risks of investing in US bonds.
See you in the next lesson!