Life is risky. Every day investors are faced with complex choices in the face of deep uncertainty. What to do? Look at history and realize that the odds favor the educated. One opportunity for learning comes in the form of corporate bond offers.

Corporations raise funds in a variety of ways - income from sales or services, straight bank loans and stock floats. One of most common but least understood methods by the average investor, though, is issuing bonds.

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Corporate or Government. AAA or Junk. Subordinated or unsubordinated. 30 year or 3 month. The list goes on.

Classifying and tracking the different types of bonds is a full-time job for many. Ok, maybe not everyone’s idea of an exciting career, but necessary and extremely helpful to the investor.

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When even the Iranian government floats Eurobonds, you know there’s something funny about the term.

There’s a difference between a eurobond and a foreign bond, even from the perspective of a non-European. A Eurobond is a bond issued and traded in a country other than the one in which it’s currency is denominated.

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Ask (Asked Price)
The lowest round-lot price a broker will offer to sell a security.

Auction
The issuance of new Treasury bills, notes and bonds at stated intervals by the Federal Reserve Bank of the U.S.

Baby Bond
Bond with a face value of less than $1,000.

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It’s often said that government bonds represent one of the lowest possible risks for an investor. In general, true - but much depends on which government issues them and which investor is buying.

Government bonds are usually sold with the wording ‘Backed by the full faith and credit of the…’ So, estimating the risk becomes an exercise in determining how much faith one places in that credit.

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First, a confession: Interest rates are unpredictable. But then, you knew that already. Fortunately, they’re not entirely unpredictable. Good bets are possible.

But before discussing some of the factors influencing them, a few words about why you should care: Price-Yield correlation. Which means what, now? As interest rates rise, bond prices fall. When rates fall, prices rise. Common sense reveals the reason.

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‘Junk’ bonds - more politely known as high-yield bonds - acquired the name as a consequence of their low rating by the major agencies and their high rate of default. ‘Default’ is the failure to repay principal and/or suspension of interest payments.

But a curious thing happened in the 1980s. Michael Milken examined the market carefully and determined that the default rate was unlikely to be as high on certain bond issues than was previously thought. The ‘high-yield’ market was born.

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Every bond carries some risk that the issuer will default on repayment of the principal or suspend interest payments. Once that risk is measured (see ‘Measuring Risk’ elsewhere in this series), then what?

First, a review.

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Few investments offer as objective an estimate of risk as bonds.

Because of some fixed characteristics - par (face value, repaid at maturity), coupon (interest rate, percentage paid in semi-annual payments on the par) and maturity (date principal is repaid) - predicting bond values and risk with some confidence is as much science as art.

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One reason stocks are more popular than bonds is that the latter are more complicated. Ironic, considering their risk and returns bonds are easier to judge and predict with confidence.

Adding to the complexity are the differing tax issues affecting bond returns.

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