Bonds could be a new topic to people who are novices in the trading sector. It is a concept that acts as a pillar to the economy when every industry is facing a challenge. When certain entities or companies want to raise funds for any new projects, refinance existing debts, or fund operations, investors are directly issued with bonds. Public trade of many government or corporate bonds is conducted on exchanges. The capital markets undergo several rises and dips, and so do the interest rates, commodity prices, and recessions. Investors can protect or profit from such changes in market circumstances by adjusting their portfolios in anticipation and reaction to the events. Here are the reasons why investors trade bonds.
1. Increase the Yield
One of the most important reasons for investors to trade bonds is the increase they need on their yield over the portfolios. If you hold a bond to maturity, you can receive a particular return, and the total amount you can expect from this program is called yield. Most investors try to maximize the return from the yield.
2. Trade After Upgrade of Credit
The trading opportunities or the repayment of obligations are reflected through the credit ratings. The rating indicates the opinion of the credit rating agencies, and any swing in it can mean scope for trade. If any sign of a debit issue being upgraded in the future is anticipated or encountered, the investor can use the credit-upgrade trade. An upgrade in the credit rating means that the company is a lesser risk to invest money into and that its business prospects and financial stability have improved. Bonds are often purchased by the investors before the credit upgrade so that they get to capture the price increase at the right time. But this would require some skill at analyzing credits.
3. Credit-Defense Trades
Some sectors become vulnerable to defaulting on the debt obligations during instability in the economy and the markets. A defensive position is what the investor will look for at this point because that will allow them to make more money out of the poorly performing sectors. Credit-defense trade can also be adopted when the investors receive signs of the industry becoming less profitable in the near future. Such situations could lead to the bankruptcy of certain companies or their exit from the market.
4. Sector-Rotation Trades
In sector-rotation trades, the capital is re-allocated to sectors that are likely to perform well in the upcoming months. One strategy that most investors adopt while allocating their capital is the rotation of bonds between non-cyclical and cyclical sectors. The investors do so in the belief that the economy is headed in a specific direction.
5. Adjustments to the Yield Curve
The price sensitivity of a bond to the changes in interest rates is known as the duration of a bond portfolio. Low-duration bonds have a lower sensitivity to the changes in interest rates than the high-duration bonds. A change in the duration of the bond portfolio is the whole concept behind the yield curve adjustment. This is done to decrease or increase the sensitivity based on your perception of the direction of interest rates.