Corporate Bond Analysis: What to Consider
by Jason Brady
Many investors have become more focused on the fixed-income market in the past several years.
While bonds have been around for centuries, the most recent surge in activity has come from investors who are searching for the age-old combination of safety and income. Many individual investors have some experience with equity markets, but those returns have not been stellar over the last decade. At the same time, very high–quality fixed-income markets like U.S. Treasuries are near all-time lows in yields.
In this article
- Why Take Risk?
- A One-Bond Portfolio
- Bond Metrics and How to Think About Them
- The Four Cs of Bond Analysis
- When It All Goes Wrong
- Credit Ratings: Meaning and Default Probability
- Margin of Safety
- A Final Key
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As a result, many folks are beginning to look at “credit.” Credit can be broadly defined as any bond that has a risk of lack of payment, but we’ll restrict ourselves in this discussion to one of the largest credit markets, corporate bonds. Because these bonds reference companies, investors who have experience with evaluating stocks should find many of the terms and tools used in the analysis of corporate bonds easy to grasp, though there are very important differences that we’ll discuss below.
The obvious, but important, question investors are trying to answer when looking at corporate credit is the extent to which a company will be both willing and able to pay coupon and principal. Clearly the risk of default is a big part of why you, as the investor, are getting paid more in yield to own a corporate bond than supposedly credit risk–free assets such as U.S. Treasuries.
Nevertheless, when times are good and trouble seems to be a long way away, it can be easy to lose sight of the things that can go wrong. I distinctly remember a very well-regarded sell-side credit analyst (whose job is to look at the risk of default in every investment he analyzes) discussing Enron in 2000. His incredulous statement about the company when queried about the complex financials was, “What are you worried about? You think they’re not going pay you back?” Though at the time the company was a well-respected high-flier, the answer to that question is always “Yes.”
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Discussion
I learned a lot about Bond issues. Thnak you very much.
Ken Suzuki
posted about 1 year ago by Kenichi from California
Finally a rare and easy to understand article about applying Bond Analysis techniques to evaluate investment risks. Well Done!!!!!
posted about 1 year ago by George from Virginia
The Bond Metric article would have been much more helpful to a mutual fund investor if the author had given:
1. Numeric comparison tables.
2. Numeric values of good ratios and poor ratios.
3. references where such values / tables could be obtained.
posted about 1 year ago by William from Pennsylvania
Certainly a lot to understand and consider.
I have for the past several years used Closed End Funds (Bonds) mostly from Pimco and Blackrock. In addition, I note what other institutions own the same fund. I use their collective analysis to make my selections.
tks
posted about 1 year ago by John from Florida
The cautions in this article point out why many investors are better off buying one or more bond funds, rather than individual bonds. A bond mutual fund typically owns a large number of carefully-researched bonds. Any default will be mitigated by the large number of holdings and experienced fund managers can (and do) adjust duration and cash to fit the current economic conditions.
posted about 1 year ago by Phil from Illinois
I agree with Philip that most individual investors should stick with bond funds. In today's environment of very low interest rates I stick with funds that invest in short term bonds.
Another way to try to provide regular income is to invest in blue chips that pay regular dividends.
posted about 1 year ago by Paul from Maryland
I'm with Paul and Phillip. Short term bond funds with low expenses.
posted about 1 year ago by John from California
One of the best Corporate bond analysis information guide I have read in a long. Very Pleased.Thanks.
posted about 1 year ago by Saroj from Ohio
My wife and I are simple people. We file a short form which I prepare using TurboTax. We are nearing retirement (I'm either retired or unemployed at the moment - I'm not sure which). This past month we took a large portion of our cash and bought a 10 year bond ladder made up of 98% investment grade and 2% high yield (bb). We picked up 20 different issuers.
To build a simple example - let's say for each issuer we have 25 bonds and the entire ladder yields 25K per year. Let's make the year 2013 and a bond with a maturity date of 2016 defaults. Assume the bond was picked up at a premium - $110.
If we get nothing back after the default - what could we recoup on our 2013 tax return ? Nothing ? The principal at par ? The principal at premium ? How about lost interest payments ?
While I've got your attention - what happens in the case where a bond is called away at par ? Is there any way to recoup the premium cost on a tax return ?
Thanks
posted about 1 year ago by Charlie from Florida
Very inciteful article.It makes the case for buying high quality individual bonds, not for buying bond funds. It is not better if the contents of the box are wrapped so you cannot know what is inside.
posted about 1 year ago by Hildy from Pennsylvania
We are now at record low interest rates. Under these conditions, if one purchases shares of anything but the shortest term mutual bond funds, and interest rates return to more "normal" levels, aren't the odds of recouping one's initial investment significantly reduced?
posted about 1 year ago by William from Connecticut
