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Finding Bargain Bonds in a Low-yield Environment

The low interest rate environment may be around for some time to come as the Federal Reserve earlier this year announced that it would likely not raise interest rates again this year and maybe even wait until 2018. I think that’s a stretch; this year or next seems more like it. But with the slowing job market ad the pending possible exit of Britain from the EU, it may be some time. Considering how low yields are right now, the thought of finding deeply discounted municipal bonds may seem unreasonable. For the determined investor, however, there are some buying opportunities that could be worth their wild.

 · Price Yield Relationshipe

When interest rates rise, bond prices fall and when interest rates fall, bond prices rise. The prices change in order for bond yields to stay in line with the yields of bonds newly sold in the primary and those being traded in the secondary market.

To determine if a bond is a bargain or discount, look at their par value. Bonds that trade, or are sold, at prices below their par values are considered discount bonds. Bonds trading above their par values are trading at a premium.

 · Where to Shop

One of the best places to shop for discount bonds is the secondary market. This is because bond prices are typically much lower here than they are in the primary market. This is especially true when rates are on the rise.

A caveat to buying discount bonds in the secondary market is the tax implications. When they are redeemed, they may be taxed at the capital gains rate.

 · When to Shop

The best time to shop for bargain bonds is when there is a lot of supply in the market. Issuers have to settle for paying higher interest rates because they know investors have a lot to choose from. The opposite is the case when there is not a lot of supply in the market.

 · Zero-coupon Bonds

Investors who can stand to wait 20 or 30 years to reap returns from their investment may consider zero-coupon bonds, which are typically available in the secondary market. This type of bond trades and is sold at deep discounts because it only pays interest at maturity instead of over time.

 · Bargains Not Just Junk Bonds

When interest rates are as low as they are now, investors may have to do more work, and make more sacrifices to find bargain bonds. One way to find these bonds is to be willing to take on more risk. This doesn’t have to mean jumping right into junk bonds or bonds that have below investment grade ratings. You may find investment-grade issuers that are facing financial problems that are willing to sell their bonds at lower prices and offer higher yields.

 · Fiscal Pressuress

To get some insight into an issuer’s credit quality, begin with their bond rating reports. Rating agencies put out warnings on issuers prior to downgrading them by either placing them on their watchlists for a downgrade or changing their ratings outlook to negative. If the rating is placed on watchlist, the issuer is under review for a potential downgrade within the three to six months. If the outlook is changed, the rating agency will likely take no action for at least six months.

Having this knowledge can help you gauge whether or not the issuer is in truly dire straits with great fear of default, or if its situation simply stems from needing to raise more revenues to cover their debts. If this issue is planning a new money deal or a refunding, they also may be more likely to offer bonds at lower prices.

Keep in the mind the that ratings information can also have positive effect on an issuer. Issuers that are improving their financial bottom lines can have an upgrade or stable or positive outlook change in store. This would cause their bonds to trade at a premium.

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