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Unit 7: Investment Strategies-II

You will also find higher coupon rates on corporate bonds than on Government treasury bonds Notes
with comparable maturities. In the corporate market, bonds with lower credit ratings typically
pay higher income than higher credits with comparable maturities.
High-yield bonds (sometimes referred to as junk bonds) typically offer above-market coupon
rates and yields because their issuers have credit ratings that are below investment grade: BB or
lower from Standard & Poor’s; Ba or lower from Moody’s. The lower the credit rating, the
greater the risk that the issuer could default on its obligations, or be unable to pay interest or
repay principal when due.
If you are thinking about investing in high-yield bonds, you will also want to diversify your
bond investments among several different issuers to minimize the possible impact of any single
issuer’s default. High yield bond prices are also more vulnerable than other bond prices to
economic downturns, when the risk of default is perceived to be higher.

Managing Interest Rate Risk: Ladders and Barbells

Buy-and-hold investors can manage interest rate risk by creating a “laddered” portfolio of
bonds with different maturities, for example: one, three, five and ten years. A laddered portfolio
has principal being returned at defined intervals. When one bond matures, you have the
opportunity to reinvest the proceeds at the longer-term end of the ladder if you want to keep it
going. If rates are rising, that maturing principal can be invested at higher rates. If they are
falling, your portfolio is still earning higher interest on the longer-term holdings.
With a barbell strategy, you invest only in short-term and long-term bonds, not intermediates.
The long-term holdings should deliver attractive coupon rates. Having some principal maturing
in the near term creates the opportunity to invest the money elsewhere if the bond market takes
a downturn.

Smoothing Out the Performance of Stock Investments

Because stock market returns are usually more volatile or changeable than bond market returns,
combining the two asset classes can help create an overall investment portfolio that generates
more stable performance over time. Often but not always, the stock and bond markets move in
different directions: the bond market rises when the stock market falls and vice versa. Therefore
in years when the stock market is down, the performance of bond investments can sometimes
help compensate for any losses. The right mix of stocks and bonds depends on several factors.

Saving for a Definite Future Goal

If you have a three-year-old child, you may face your first college tuition bill 15 years from now.
Perhaps you know that in 22 years you will need a down payment for your retirement home.
Because bonds have a defined maturity date, they can help you make sure the money is there
when you need it.
Zero coupon bonds are sold at a steep discount from the face value amount that is returned at
maturity. Interest is attributed to the bond during its lifetime. Rather than being paid out to the
bondholder, it is factored into the difference between the purchase price and the face value at
maturity.
You can invest in zero coupon bonds with maturity dates timed to your needs. To fund a four-
year college education, you could invest in a laddered portfolio of four zeros, each maturing in
one of the four consecutive years the payments will be due. The value of zero coupon bonds is

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