Eccleston Law: For Investors. For Advisors
About
Who We Are
Testimonials
Disclaimers
Attorneys
For Advisors
Broker Transition
Transition Contract Review
Employment Matters
State Registration Problems & Discipline
FINRA Matters
Promissory Note Matters
Team/Parnership Disputes
CFP Board Matters
FINRA Enforcement Matters
State Registration Problems & Discipline
Transition Contract Review
Broker Litigation & Arbitration
Employment Matters
Regulatory Matters
Strategic Consulting
Whistleblower Law
Promissory Note Matters
Compliance Protection
Lawyer Referral Network
Expungement of CRD/BrokerCheck Disclosures
For Investors
Securities Fraud
Breach of Fiduciary Duty
Retirement Planning Negligence
Unauthorized Trading
Lawyer Referral Network
FAQs
News & Articles
News
Articles
Financial Counsel Blog
Videos
Newsletter Signup
Contact
Site Menu
About
Who We Are
Testimonials
Disclaimers
Attorneys
For Advisors
For Advisors: Overview
Broker Transition
Broker Transition Overview
Transition Contract Review
Employment Matters
State Registration Problems & Discipline
FINRA Matters
Promissory Note Matters
Team/Parnership Disputes
CFP Board Matters
FINRA Enforcement Matters
State Registration Problems & Discipline
Transition Contract Review
Broker Litigation & Arbitration
Employment Matters
Regulatory Matters
Strategic Consulting
Whistleblower Law
Promissory Note Matters
Compliance Protection
Lawyer Referral Network
Expungement of CRD/BrokerCheck Disclosures
For Investors
For Investors: Overview
Securities Fraud
Breach of Fiduciary Duty
Retirement Planning Negligence
Unauthorized Trading
Lawyer Referral Network
FAQs
News & Articles
News
Articles
Financial Counsel Blog
Videos
Newsletter Signup
Contact

SEC Publishes Informative Investor Bulletins Discussing Characteristics of Bonds

Posted on July 2nd, 2013 at 10:15 AM

The Securities and Exchange Commission (SEC) has published several Investor Bulletins regarding bonds.  They cover corporate bonds, high-yield corporate bonds, municipal bonds and the relationship between bond prices and interest rates.  Let’s summarize the important advice for investors which the SEC provides in those four bulletins.

            First, let’s review the guidance with respect to corporate bonds.  All bonds have a certain maturity.  Maturities can be short term (less than three years), medium term (four to ten years) or long term (more than ten years).  Bonds and the companies that issue them also are classified according to their credit quality.  There are investment grade and non-investment grade (“high yield”) bonds.  Bonds pay interest, but how they do so varies.  Many bonds pay a fixed rate of interest throughout the term of the bond, and their interest payments are called coupon payments.  Other bonds pay floating rates that are reset periodically in relation to changes in market interest rates.  Still other bonds pay no interest payments until the bond matures.  That type of bond is called a zero-coupon bond.

            When a company goes into bankruptcy, corporate bondholders will have a claim on the company’s assets and cash flows.  But their place in line will vary and will depend upon the priority of their claim.  There are secured bonds, senior unsecured bonds and junior unsecured bonds.  Bonds with no collateral pledged to them are unsecured and may be called debentures.

            Apart from that credit or default risk, bonds face other risks.  They face interest rate risk, as discussed below, as well as inflation risk (inflation reduces the purchasing power of the bond’s interest payments), liquidity risk (lack of liquidity affects marketability and hence the price at which an investor can sell the bond), and call risk (bonds paying too well for investors sometimes may be called back by the corporation, leaving investors with a refund of their investment but no investment of similar quality in which to reinvest).

            A close cousin to the corporate bond is the high-yield bond.  High-yield bonds are issued by companies that face a greater default risk.  They pay a higher interest rate because they must do so to attract investors.  In addition to the risks detailed above, high-yield bonds face economic risk.  That is the risk that if the economy falters, investors first will dump their default-prone high-yield bonds and do what is known as a “flight to quality” – buying U.S. Treasuries typically.  As the flight to quality continues, having more sellers than buyers results in lower prices on the high-yield bonds.  During extreme sell-offs, prices fall dramatically.  Under the worst conditions, there is a risk that no liquid market exists because there are no buyers willing to buy the bond – at any price.

            The SEC cautions that investors considering high-yield corporate bonds must review the prospectus and consider (or at least attempt to understand) the bond offering, the financial condition of the company, how the company plans to use the bond proceeds, the terms of the bond and the significant risks.  In particular, the SEC recommends studying the covenant protections, the payment terms and the call provisions.

            The SEC likewise provides guidance with respect to municipal bonds.  Municipal bonds are either General Obligation Bonds or Revenue Bonds.  Investors carefully should review and attempt to understand the risks of revenue bonds, because interest payments and principal can be paid only from the project or entity involved, and not from the general funds of the municipality.  The Official Statement is a document that details both kinds of offerings.  In particular, and with respect to revenue bonds, the Official Statement usually contains a feasibility study showing the key assumptions made in evaluating the project.

            Beyond that, municipal bond investors need to understand the financial condition of the bond issuer.  In the case of revenue bonds, it is important to know whether the bonds are “non-recourse”; in other words, if the revenue is insufficient to pay bondholders, are there any other sources of revenue which will be used to repay the bondholders. 

            The fourth publication gives a detailed explanation of the relationship between interest rate movements and the prices of all types of bonds.  In short, the price of bonds moves inversely to interest rate movements.  Conversely, fixed rate bond yields move in the same direction as interest rate movements.

            Another risk that the SEC describes relates to bond insurance or government guarantees.  Often those claims are made.  But, even if there is insurance of a government guarantee, the market price and the value of all bonds do fluctuate.  In short, the insurance and the guarantee apply only when the bond is held to maturity.

            As one can see, the SEC bulletins provide helpful information to investors considering bonds.  They are a worthwhile read.

Tags:

Share

Return to Archive

Latest Articles
Advisor Team that Left Morgan Stanley Files Counterclaim Seeking to Prohibit Firm from Soliciting Clients
January 21st, 2021 at 3:33 PM
Insurance Agent Continues to Sell Despite Lengthy Disciplinary History
January 20th, 2021 at 4:23 PM
Read More »
Latest News
CFP Board is the New Sheriff and it Is Not Your Friend
October 24th, 2020 at 10:04 AM
Defending Against a Customer Complaint First Requires Selecting Correct Legal Counsel
October 15th, 2020 at 10:02 AM
Read More »
Share

Request a Free Consultation

Attorneys are standing by during regular business hours. Call us now for immediate service, or complete the form below and we will contact you as soon as possible.

Your E-mail Address:
 
Chicago
55 West Monroe St.
Suite 610
Chicago, Illinois 60603
(312) 332-0000
(312) 332-0003
New York City
One Liberty Plaza
165 Broadway, 23rd Floor
New York, New York 10006
(312) 332-0000
(312) 332-0003
Boca Raton
2255 Glades Road
Suite 324A
Boca Raton, Florida 33431
(312) 332-0000
(312) 332-0003
2021 © Eccleston Law, LLC.
All Rights Reserved.
The law is continuously changing. Please do not rely on information found on this site without consulting a lawyer to determine if any recent changes in the law may have an impact.