Interest Rates and Bonds
Interest rates and bonds are terms used in finance, and one is dependent on the other to function. The meaning of the two phrases must be understood; the interest rate is the expense incurred when a person borrows money from another person or an organisation. A bond, on the other hand, is the amount of money that an investor lends to a certain organization or corporation over a specified time period in exchange for an interest rate or a variable. The bond is typically issued by the government to support various initiatives such as the construction of national roads or railway lines. The interest rate of a bond given to a government for instance is calculated in terms of percentage in an annually manner depending on the amount of the bond allocation. The bonds can be refer to fixed-income securities and consist of three things: the asset classes, cash equivalent, and the stocks. The governments and corporate bonds mainly traded on an exchange on a public platform. This paper will elaborate on how the interest rate can affects the assets, supply, and the demand of the funds by the corporates and governments and the explanation in depth about the bond performances and its benefits to the society.
Interest Rates and Interest Rate Movements
The interest rates and interest rate movements determine the possibilities of the lender giving out the loans or declining to the corporate or the government. Various things make the interest rates to shift in either direction. Indeed, an increase in inflation makes a direct proportion increase in the interest rate whereas a decrease in the inflation causes a decrease in the interest rate. Inflation increase affects the investors so much that the prices of the bond invested decreases when a purchase made. Actually to give an explanation about the changes inflation is that, bonds paid off at a lower price after it has mature thus the investor will not get the worth of the investment given out to the corporates or the government. Conversely, a decrease in inflation will benefit the investor in that the value of the bond purchased by the corporates decreased since the interest rate decreased.
Inflation Changes and the Demand and Supply of Bonds
The inflation changes determine on the demand and the supply of bonds by the investors to the corporate and the governments. The investor is attracted to the low inflation rather than the higher inflations situations in the market. It is easy for the investor to lend out the fund to the corporates if interest rates is lowered , this is the opportunity for the investor so good returns will be attained at the end of the period set in the contract between the lender and the corporate. The demand for the bond increases when there is increase inflation in the global markets, this attract many corporates that want to fund their projects at a given period. However, the number of the investors will be less since they fear losing their money at such time of increase inflation in the market; the higher interest rate lowers the prices of bonds while the low interest increases the corporate bonds prices.
Impact of Interest Rate Increases and Decreases on Bond Investments
The investors get a loss of the investment when the interest rate increases after making a purchase of bond for a given period. This happen when other investor arise with intention of purchasing bond but willing to purchase it on the current interest rate which a bit higher than the one used by the investor before thus ending up receiving less money that those invested. Nevertheless, the investor will make profit if the interest rate decrease as compare to the previous one used in purchasing the bond. The purchase of the bond therefore calculated using the current interest rate in the market hence increasing the value that the investor will receive.
Consideration of Long-Term Bonds and Market Conditions
It is advisable for the investor to prefer long-term bonds since the interest rate changes will not affect so much the purchasing power at the end of the stated period with the contractor. This happens since the interest will accumulate over a given period building up the bond portfolio. The current market conditions that can be either favorable or unfavorable affect the demand of the bond. In a favorable situation, there will be more demand of the bond by the investor compared to the unfavorable time where the demand decreases scaring away the investors. The interest rate risks calculation and the future demand of the bond predicted so as the investors not to incur huge losses by purchasing bonds at a rate that might lower after a given period.
Comparison of the US Treasury, Corporate, and Municipal Bond
The Treasury Bonds and Municipal Bonds enable the investors gain some profits after investments interest rate paid back by the corporate or the government. Indeed the treasuries are loans that the investors give to the government thus helping the same government fund the national debt of a given period, whereas on the other hand the municipal bonds representing investments the corporate or the government to complete projects such as the constructions of the infrastructures. The treasury and the municipal differences identified in the way they are tax and on the level of credits risks, that each encounters over a given duration. The comparison is not that easy since the bonds may differ in terms of the frequencies and the interest's rate is not equal since the number of the days a year varies from one another.
The Treasury Bonds
The treasury can be; bills, notes or even bonds under the government of US. The Treasuries bills can be define as those debts that issued having a maturity of one year and below. The treasury bills are purchased at a small discount and then mature at their full face value of $100, (Scott Krohn, 2011). According to Scott Krohn(2011) further explained that the differences of the prices is the interest earned. A good example is as follow same done by author Scott krohn(2011), "a 52 -week Treasury bill that is purchased at $99.25 would mature at $100. There is a gain of 75 cents which can represent 0.75 percent."
Types of Treasury Bonds
The Treasury notes mature after a period not less than one year up to ten years whiles the Treasury bonds takes the longest time to mature which is more than 10 years. The Treasury bills are the only one that does not pay the interest while the Treasury bonds and Treasury notes pay interest rate at an interval of 6 months. When the Treasuries bought and sold, there are intermediates that come to act as the link between the two parties that are entering into the contract having a charged fee than one as to pay subject on the institution.
Municipal Bonds
The Municipal bonds on the other hands as the name suggest are those bonds that issued by the cities, states and other state agencies for the purpose of funding community based projects like schools improvements in the society. The Municipal bonds are non-taxable by any state or federal government but it is compulsory to provide payment of interest for every 6 months. There are two different types of Municipal bonds, this being the general obligation and revenue bonds. The general obligation bonds paid through the local taxes by the states in contrast, the revenue bonds paid by those projects funded through the collection of income after those projects are completed.
Credit Risks
In addition to looking at the credit risks measurements, the Treasuries do not face credit risks thus the Municipal bonds exposed to those risks. Those risks affected by the health of the issuer since the credits risks evaluated under given values that enable investors in determining the level of risk.
Conclusion
In conclusion, it is good for any investors to consider the interest rates fluctuation in the market before buying or selling the bonds to the corporate and governments. This will help in avoiding any future losses that could be avoided if enough precautions are undertaken. The inflation rates can affect the purchasing power of bonds at a given time in the society. The investors receive a lot of profit if the inflation decreases hence decreasing the interest rates. The bonds are important in the development of corporate and government. Actually, one of the government projects that benefits from bonds lending is the infrastructures. This will make the transportation accessible and thus income can be generated to repay back the bonds with the interests.
The Demand and Supply of Bonds
The demand and supply of the bonds are affected by the interest rate over a given period. High inflation rate lowers the demand of the bonds purchase by the investors while on the other side lower inflation rate attract more investors who want to purchase the bonds. Bonds are in two different types the Treasury bonds and Municipal bonds. The supply of money also affects the buying and selling of bonds to the corporate and the government.
Task 2
Comparison of the US Treasury, Corporate, and Municipal Bond
Work Cited
Bodie, Zvi. Investments. McGraw-Hill, 2013.
Krishnamurthy, Arvind, and Annette Vissing-Jorgensen. "The aggregate demand for treasury debt." Journal of Political Economy 120.2 (2012): 233-267.
Starks, Laura T., Li Yong, and Lu Zheng. "Tax‐Loss Selling and the January Effect: Evidence from Municipal Bond Closed‐End Funds." The Journal of Finance 61.6 (2006): 3049-3067.
Scott Krohn, T-bond and Municipal Bonds,2011
