Switching Tendencies to Mounting Bond Investments - Essay Example

Bond is a long-term financial instrument that is mainly traded by large corporations and a government (Class PPT, 2009)1 for the purpose of raising money (Investopedia, 2009).2 Bonds are also issued by governments in order to provide secure long-term investments of individuals in such institutions as pension funds (Ming, 2009). A borrower (issuer) is obliged to pay principal and interest on a predetermined date (maturity) to an investor (bondholder) (Class PPT, 2009). In contrast to other financial instruments, the bond's rate of return is lower due to lower perceived risk of default.

However, in case of such an incident, investors still get a lower return (Class PPT, 2009). That fact always makes investors cautious in choosing a reliable institution for investment. Moreover, the crisis emanated in March of 2007 made the current financial situation rather volatile and unpredictable. The situation discouraged business lending and stimulated the purchases of governmental Treasury notes (Hilsenrath, 2009).The current financial situation stimulated investors' demand for greater security of their capital.

The high unemployment rate implies difficulty in setting adequate interest rates (Hilsenrath, 2009). Moreover, worsened credit quality offsets economic activity as well: banks prefer low yielding Treasury bonds to lend to businesses (Hilsenrath, 2009). During the crisis, most popular investments are corporate, municipal, and treasury bonds (Opdyke, 2009), - the three lowest risk and rate yielding bonds. Business lending contracted by 17% if the same data to be compared to the previous year (Hilsenrath, 2009).

At the same time, taxable bond investments almost doubled for the past two years (Opdyke, 2009). These data imply that the investors are ready to sacrifice their potential higher returns for assurance to get the par value at maturity (Ming, 2009). However, such trends of bonds' investments are notable only in the developed countries that promise a somewhat stable financial prospect (Ming, 2009). There are several factors affecting the default risk of a bond issuing institution. Among them are earnings stability, controlled environment, and bond rating (Class PPT, 2009).

First, before making an investment, it is rather important to ensure that a bond issuing company has positive financial statements (Opdyke, 2009). Second, the environment should be well regulated, trust in a relatively stable economic situation allows for long-term investments (Ming, 2009). For example, China's adequate fiscal situation and the need for money stimulated demand for bonds. Investors were ready to buy 50-year bonds to be certain that by the end of this period, they will be able to obtain certain expected value of their investments (Ming, 2009).

Finally, bond's rating by such rating agencies as S&P or Moody's signifies the probability of bond issuer to default (Class PPT, 2009). Currently, it is rather difficult to make an investment in highly rated bonds. However, investors are still willing to do such, even if it is a "junk" rated Baa3 (Opdyke, 2009). Obviously, investors put much trust in long-term bonds. However, such a heavy reliance on bonds' market is not as riskless as it seems. The current market situation is volatile. If rates increase, they would make an adverse effect on the prices of individual bonds and harm investors (Opdyke, 2009).

For that reason, long-term investments are not safe. Short-term investments, however, give higher flexibility for reinvestment (Opdyke, 2009) and greater return (Class PPT). As it was suggested by Opdyke, if an investor does not hold 300,000 USD to diversify the portfolio, the second-best strategy is "laddering." Investing in bonds that mature in consecutive intervals gives an opportunity to reinvest according to changing interest rates (Opdyke, 2009). In the period of rather unstable financial situation, more preference is given to long-term debt financial instruments.

Investors are wary of bond issuers' default risk and ready to sacrifice a higher return on investment for the security of their funds. However, investing in bonds long-term maybe not as reliable as short-term due to still fluctuating and unpredictable interest rates.