Toucan Talk
Of Interest - Bond Fundamentals
Provided by mjoM@tiecahmaoealnOa.aconma

Michael Oana is the Chief Investment Officer with Team Oana Investment Advisors. Team Oana is a locally owned boutique investment firm specializing in helping conservative investors. Mr. Oana's Toucan Talk column appears bi- weekly in TheColumbiaStar.

The evolution of the securities industry has brought a wide variety of ways to invest in fixedincome securities. Investors concerned about credit risk can stay with U.S. Treasury securities for the highest credit quality. Investors looking for yield can consider bonds with less credit protection and more potential income. Maturity requirements can be met through just about any of the fixed-income investments available. However, all types of fixed-income investments are based on the same fundamentals - chiefly the inverse movement of price and yield. This relationship is confusing to some investors. Here we'll try to remove the mystery.

Price and Yield Move Inversely

The most important rule to remember in understanding a bond and its characteristics is that when interest rates move up, the prices of existing bonds generally move down. Conversely, when rates move down, bond prices generally move up.

To understand why this happens, we need to look at an example. Let's say that on July 1, you buy a new ten-year $1,000 bond paying 6%. It pays you $60 a year in interest.(1)

But six months later, new bonds are paying 7%, or $70 a year. Your 6% bond is now worth less than $1,000 - because $1,000 will now buy $70 a year, and the 6% bond still pays only $60. The price of the 6% bond now falls to where its yield to maturity (a current buyer's annualized return on investment if the buyer holds the bond to maturity) equals the going interest rate of 7% - somewhere around $940.

So if you sell a bond before it matures, and interest rates are below the original rate, the price you receive will probably be above face value. If rates are above the original rate, the price you receive will probably be below face value. When interest rates move, the prices of existing bonds move the other way.

Price Sensitivity

As interest rates change, bond prices move more or less quickly depending on a couple of variables.

• First and foremost, the longer a bond generally has to maturity, the more sensitive its price movement will be. • The lower a bond's coupon (stated interest rate), generally the more sensitive its price will be.

Hence the most sensitive or volatile of all bonds is one that generally pays no interest and has a long maturity - a long-term zero-coupon bond. These are issued by the Treasury as well as by corporations.

A "zero" is issued at a deep discount, compounding steadily until it reaches par ($1,000) at maturity. Be aware: even though you receive all the interest at the bond's maturity, you are taxed on the interest as it accrues each year, even though you receive no income payment.

This steady accretion is important when the investor wants to take advantage of an anticipated movement in interest rates.

For example, a hypothetical 10- year zero compounding at 6% may have an issue price of around $554.(2) A year later ...

• If rates had moved up to 7%, the zero should be priced to pay 7% to maturity, about $538. The investor who sold at this point would have a loss of $15.

• If rates were still at 6%, the zero should be priced to pay 6% to maturity, around $587. The investor who sold at this point would have a gain of about $33.

• If rates had moved down to 5%, the zero should be priced to pay 5% to maturity, around $641. The investor who sold at this point would have a gain of $87.

The inverse relationship of interest rates and bond prices is fundamental to all fixed-income securities. Keeping it firmly in mind can help you take advantage of interest-rate movements. For guidance on your portfolio strategy, talk with your financial advisor.

(1) Prices and yields are for illustrative purposes only and may not be representative of those currently available. Figures shown do not include taxes or commissions.

(2) This example is hypothetical and uses theoretical values for the bond over time and under different market conditions. Actual bond values also vary with a number of factors not included in this example.

The accuracy and completeness of this article are not guaranteed. The opinions expressed are those of the author(s) and are not necessarily those of our firm or its affiliates. The material is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

Team OanaInvestment Advisors,Inc.,

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Brokerage Services,Inc.Member

FINRA & SIPC.

Please listen in on the "U Need 2 Know" radio show on WOIC 1230 AM. Mr. Oana will be a guest every third Wednesday of each month at 3:05 to 3:25 pm. Looking for a great guest speaker for your next event? Please call Staci Goins at 803-343-3343 to schedule Mr. Oana to speak for your group.