Ken Himmler.com

Even if you fully intend to carry a bond through to maturity, the issuer of the bond may have other plans. If interest rates fall heavily and the issuer of your investment bond opts to lower its interest rate expenditures then they may exercise their right to redeem or call in their bonds even before they mature.

If you own a bond that is “callable” then there is some risk of this happening if interest rates drop to attractive levels for the issuer. Should this occur, the issuer will only be required to pay you par value for the bond and this will result in you receiving less than the current market price.

One of the unfortunate aspects of having a bond called is that the market environment that motivates issuers to redeem a bond is the same that often leads to higher bond prices. So not only do you lose the potential of a pre-maturity profit by selling the bond, you’re forced to sell earlier and for less money than you want.

While many callable bonds will have call protection where the bonds can’t be called for a certain period of time, you won’t have any choice but to take par value when and if they do opt to call it in.

It needs to be said that even if interest rates fall, this doesn’t mean your bonds are automatically going to be called in. The issuer will have to see that it can lower its costs by redeeming the bonds at par value and then selling additional bonds with lower yields. Typically, interest rates would have to drop significantly for this to happen.

Because callable bonds carry the risk that you won’t get the return you anticipate, they typically pay a higher rate of interest than non-callable bonds. When considering bond investments, you’ll want to weigh the pros and cons of higher interest/higher risk or lower interest/lower risk depending on your investment goals.

In today’s volatile market environment, more and more investors are seeking refuge in stability. When most people think about investment bonds they conjure up words such as safe, steady, reliable.

In reality, it is still possible to lose money in bond investing which is why investors are urged to diversify their bond investments. By building a portfolio of investment bonds with varying interest rates, maturity dates, and associated risks such as creditworthiness, you can better protect the overall return on your investment.

Many people are aware of the obvious risks in bond investing, such as the issuer going bankrupt or defaulting on scheduled interest payments, but what about the less obvious risks that can still impact bond investment return?

While it’s true that the interest payments you will receive from owning an investment bond will be steady, the actual return that you receive when you sell your bond can vary. Let’s explore how the risk of interest rate fluctuation can influence the profit or a loss you take on your bond investments.

You may think that a higher interest rate would equate to a higher return, but the opposite is true in bond investing. When interest rates rise, it is highly probable that the issuer will offer new bonds with a higher paying interest rate. If this happens, then the value of older, lower-yielding bonds will take a hit. Given the choice, investors will opt for the higher interest return and this will impact your ability to sell.

It’s important to note that this fluctuation only applies to investors who opt to sell or trade bonds before their maturity date. If you hold an investment bond to maturity then you will be paid the full face value of the bond. That said, planning to hold a bond to maturity still doesn’t guarantee a return. In fact, interest rate fluctuations, especially a fall, can still impact your bond investments.

For example, if interest rates fall significantly, as they certainly have over the past year, bond issuers may opt to exercise their right to call in their bonds even before maturity. In our next post, we’ll explore why this happens and how exposed you are to the risk of having a bond called in early by an issuer.