How to Evaluate a Bond. It can be difficult for novice investors to understand the different features of bonds and which ones fit their investment objectives. This article shows you how.
The first question that all bond investors must ask is: which type of bond to buy--government, municipal or corporate? The answer will depend on the investors's risk tolerance and tax bracket. High income investors will benefit from the tax-free status of municipal bonds, while those who cannot afford to risk their principal will look to government bonds for safety. Low and middle-income investors seeking higher rates are appropriate candidates for corporate issues.
Government bond investors must choose between treasury bills, notes and bonds based on their time horizon to maturity. Investors who will need their money in a year or less will buy T-Bills, while intermediate term investors (1 to 10 years) will go for notes. Long-term investors (10 to 30 years) will put their money in T-bonds.
Municipal bond investors should look at the financial stability of the issuer which is usually assigned a rating such as AAA by agencies like Moody's or Standard and Poor's. Many municipal offerings are also insured by AMBAC to assure return of principal for investors.
Financial stability and rating is an issue for corporate bond investors as well, except that AMBAC insurance is not available for corporate issues. However, both corporate and municipal investors must consider put and call features that are included with their bonds. A call feature allows the bond issuer to buy back the bonds at a preset price and time such as within a 90-day period that begins five years after the bond was issued. This allows issuers to escape having to continue paying bondholders a higher rate than the prevailing market if interest rates drop after issuance.