The bond market always seems so confusing to almost everyone. It does look to be upside down. Why is it so?

When an investor buys a bond that matures in 20 years he plunks down his cash, say $10,000, and each quarter (or annually or as agreed) the bond issuer sends him a check for the interest. If it was 6% the bond holder will receive $600 annually until the twentieth year when the bond issuer returns his $10,000. Very simple.

But suppose the bond owner suddenly has a need for cash and must sell the bond. The bond issuer is not required to take back the bond until the 20th year. The investor must find someone to buy that bond now. Of course, the new owner will then receive the interest checks. The bond is still worth $10,000 at maturity so it should bring $10,000 on the open market. Or will it?

Not necessarily.

If the interest rate market has fallen to 3% for this type of bond then it should sell for an amount that will yield $600 on an amount of money at 3%. Now that bond is worth $20,000 ($600/.03X100). Conversely, if the interest rates have increased to 9% the amount received from the premature sale of the bond will fall to $666 ($600/.09X100). The bond holder gets less for the bond than the face amount, but the new owner will receive the full amount at maturity. The amount received from the sale is directly related to the current yield for bonds of the same quality.

As the interest (yield) goes up the principal amount the bond holder can realize from the sale of the bond goes down. As the yield drops the bond can be sold for more than the face amount, but will still bring the face amount at maturity. The amount of time to maturity is not being considered; however, the closer to maturity the more value the bond will have.

When an investor buys a bond he wants two things: safety of principal and return on his investment (ROI). There is no consideration for appreciation of capital. There are many types of bonds and they are rated in term of safety. The number one safety is the U.S. Treasury Bond. It is where almost every foreign government invests its money even beyond their own government securities. There are various rating agencies with the best known being Moodys.

Bonds are rated from AAA to junk with the latter being speculative with the chance they could default meaning you lose your money. Even better graded bonds such as municipals are questionable, but these and other bonds can be bought with insurance to guarantee you will get your money back.

Most financial advisors recommend that portfolios contain a higher percentage of bonds as people get older. That is for the investor to decide.

Each person must determine risk versus guaranteed return.

Al Thomas

Albert W. Thomas has spent most of his life in the field of finance. In 1965 he founded an insurance holding company, Security Dynamics Investment Corporation, after having been an agent and General Agent for several life insurance companies. In 1970 he became cofounder and president of Real Life Estate, Inc., that marketed a unique real estate and life insurance package.

After he became interested in commodities he bought a seat for his personal trading on the Chicago Open Board of Trade, which is now known as the MidAmerica Commodity Exchange. Later he became a full time trader and also acted as a commodity broker for a few select clients. By fellow floor traders Al is considered to be an excellent technical analyst much of which is outlined in his book IF IT DOESN'T GO UP, DON'T BUY IT! It became a best seller on Amazon.

In 1981 he sold his membership on the Exchange and with his wife, Carolyn, lived full time aboard their 41' ketch, the Aumakua (which means guardian angel in Hawaiian). They sailed in Florida and the Bahamas for two years.

He founded World Trading Group in 1984 that grew to the seventh largest introducing commodity brokerage firm in the U.S. with 35 offices from coast to coast, Alaska and Canada. It was sold in 1992.

Al is a graduate of Northwestern University with a B.S. degree in Commerce and is a member of MENSA. He is now president of Williamsburg Investment Company that syndicates his weekly financial column since 1999 to more than 300 newspapers and writes a financial market letter called Over My Shoulder that is quoted in Barron?s and many other publications. A 3-month trial subscription is available on his web site. He is a regular guest on several financial radio talk shows.

His favorite pastime is fishing.

Mr. Thomas is available for speaking engagements. Please call 321-453-5300 for more information.