Bond Market Update

Why bonds?
Here at Raymond James, we believe that bonds can play an important role in a well-diversified portfolio, helping minimize its overall volatility. Bonds may provide predictable income and, most important, principal protection.*

Who invests in bonds?
Bonds can benefit any investor’s portfolio in a variety of ways. For retirees, bonds may provide a predictable income stream and safety of capital. For other investors, bonds can help meet future obligations, such as vacations, college funding or the purchase of a house.

How much to allocate to bonds?
Bond allocation depends on many factors, including an investor’s time horizon, risk tolerance, need for income and future goals. In most cases, as investors age, they grow more dependent on income from their portfolios and become more risk adverse. Bonds can help ease specific concerns that arise when investors move from one stage of their financial journey to the next. Consult your financial advisor to determine what portion of the portfolio should be devoted to bonds based on your specific investment objectives.

*If held to maturity, subject to issuer credit risk. The market value of bonds is subject to market fluctuation and may be worth less than the original cost upon redemption (or maturity).

What are bonds?
Bonds are debt securities issued by corporations, governments and municipalities. Bonds are similar to IOUs: investors lend money to a corporation and in return receive interest payments. The corporation is obligated to return the principal to investors on a predetermined date in the future. When purchasing bonds, investors become creditors of the issuer, therefore, having priority claim on the issuer’s assets in the event of bankruptcy.

Bond Characteristics
– Par or face value is the bond’s denomination and the amount returned to the investor upon maturity. Par is not the price of the bond. The price fluctuates throughout the lifetime of the bond. If the price is above par, the bond is selling at a premium. If the price is below par, the bond is selling at a discount. Price is generally quoted in percentage of face value. For example, a price of 98 means 98% of the bond’s $1,000 par value or $980.

– Coupon rate (or just coupon) is the interest rate paid to investors as compensation for the loan. Coupon payments are generally made semi-annually unless otherwise stated. Many investors depend on this predictable income.

– Maturity is the term of the bond’s life. Bonds range in maturity from three months to 100 years. On the maturity date, the bond's face value is repaid to the investor and the interest payments stop.

– Call features are issued with some bonds and give the issuer, at its discretion, an option to redeem the bond (pay back the principal) prior to the maturity date. The bonds become callable when the situation is most beneficial for the issuer. In general, bonds are called when market interest rates fall, allowing the corporation to issue new bonds with a lower coupon rate. For taking on the risk of a possible call prior to maturity, investors are usually compensated with a potentially higher return at the time of purchase.

– Credit rating is a reflection of a company’s credit worthiness. Just like individuals, corporations with poor credit have difficulty finding financing at lower costs. “Junk bonds” or high-yield bonds have a higher risk of default and, therefore, must offer investors a higher stated return on the borrowed money. High-yield bonds (below investment grade) are not suitable for all investors.

Price/Yield Relationship
Yield is the annual rate of return investors earn based on a bond’s coupon rate and its current market price. When interest rates rise, the price of an existing bond falls because its coupon becomes less attractive for potential investors. The opposite happens when interest rates fall. Hence, the price of the bond and its yield have an inverse relationship.

Types of Taxable Bonds

– U.S. Treasury bonds are issued by the United States government, non callable, and are generally considered the safest of all investments. These bonds can be purchased through your financial advisor or directly from the U.S. Treasury.

US government bonds are guaranteed by the US government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. US government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government.

– Agency bonds are issued by government-sponsored enterprises (GSE) and carry AAA rating.

Major issuers are:

• Fannie Mae (Federal National Mortgage Association)
• Freddie Mac (Federal Home Loan Mortgage Corporation)
• Ginnie Mae (Government National Mortgage Association): backed by the full faith and credit of the U.S. government. Subject to market risk.

Both Fannie Mae and Freddie Mac are government sponsored entities and operate as public companies. Although both were created by congressional charters, neither is a government agency. Their securities do NOT constitute debt of the United States and are not guaranteed by the federal government.

– Corporate bonds are issued by U.S. and foreign companies. Because these bonds carry more risk than U.S. Treasury bonds, they offer higher yields. Before investing, consult your financial advisor about the bond's call features and credit rating.

– Brokered certificates of deposit (CDs) are issued by financial institutions, such as banks, and are sold directly through brokerage firms like Raymond James. Brokered CDs have characteristices similar to a bond, but they are FDIC insured for up to $100,000 per institution, per beneficial holder. Some retirement accounts may qualify for FDIC insurance coverage of up to $250,000. FDIC insurance coverage does not aply to any principal losses that may be incurred. Consult your financial advisor for more information about the difference between regular bank CDs and brokered CDs. To learn more about Brokered certificates of deposit, please read our Disclosure Document (PDF)

– Preferred securities offer certain benefits of both stocks and bonds. They are most suitable for investors with a long-term time horizon who are interested in a fixed rate of return. Unlike common stocks, most preferred securities are issued with a fixed dividend or interest rate which is typically paid quarterly, and most have a par value of $25 per share. Since most preferred securities are considered debt and are senior to common stock, they enjoy a priority claim over common stock on assets of a corporation in case of a liquidation; however, they are often junior to bond holders. They generally have a much longer term maturity than bonds, and in a number of cases they are perpetual. Some preferred securities are subject to unique risks which include the fact that the issuer may defer interest payments for up to 10 years. However, the investor will be liable for income tax on accrued but unpaid "phantom income." Further, dividend payments are not guaranteed and will only be paid if interest payments on the underlying obligations are made, which are dependent on the financial condition of the issuer. In addition, most preferred securities are callable at the option of the issuer, just like bonds, and may be subject to tax event or special event calls. The market value is sensitive to changes in interest rates. Unlike common stocks, preferred stocks do not have voting rights.

– Mortgage-backed securities (MBS) are issued by government agencies and carry an implied AAA rating. MBSs represent a share ownership in a group of mortgages. When homeowners make their monthly mortgage payments, the interest and principal are used to pay interest payments to MBS investors. These securities are subject to pre-payment risk as well as market and interest rate risk.

A more complex type of MBS is a collateralized mortgage obligation (CMO). The mortgage pool is divided among different classes of investors with corresponding different rates and maturities. The prepayments from mortgages are used to pay off bonds in the order specified in the prospectus. A CMO's yield and average life will fluctuate depending on the actual rate at which mortgage holders prepay the mortgages underlying the CMO and changes in current interest rates.

Types of Tax-Free Bonds

Municipal bonds
Also known as “munis,” municipal bonds are debt obligations issued by state and local governments in addition to other governmental entities to fund the building of highways, hospitals, schools and sewer systems, along with many other projects for the public good.

Munis are attractive to investors in high tax brackets because, in most cases, the interest income is excluded from federal income tax calculations. If an investor owns municipal bonds issued within their state of residence, interest income may also be excluded from state and local taxes. A limited number of municipal issues are considered an item of tax preference for calculating the federal alternative minimum tax (AMT) imposed on individuals and corporations.

Taxable municipal bonds are an entirely separate market within the municipal sector where interest income is included in federal income tax calculations. However, these issues still offer a state—and often local—tax exemption to investors residing within the state of issuance.

Taxable municipal bonds exist because the federal government will not subsidize the financing of certain activities which do not provide a significant benefit to the public at large. Investor-led housing projects, local sports facilities, refunding of a refunded issue and borrowing to replenish a municipality’s under-funded pension plan are just four types of bond issues that are federally taxable. Yields on taxable munis are typically comparable to those of other taxable issues, such as agencies and corporate bonds.

Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment.

Bonds vs. Bond Funds

Conclusion: Whether to invest in individual bonds or bonds funds is every investor's personal decision based on investment objectives, and factors that apply to his or her particular situation.

Investors should carefully consider the investment objectives, risks, charges and expenses of bond funds before investing. the prospectus contains this and other information about the funds. The prospectus is available from your financial advisor and should be read carefully before investing.

Diversification does not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss.

Bond Ladders

One of the most successful investing strategies in fixed income is diversification by laddering maturities. This investment technique provides the benefit of blending the higher rates usually associated with long-term bonds with the liquidity of short-term maturities. The resulting diversification helps reduce risk, improve returns and allow for reinvestment flexibility, while also providing liquidity and predictable cash flows.

A laddered portfolio is structured by purchasing several bonds with consecutive maturities. As each bond matures, proceeds are reinvested in a new bond having a maturity that corresponds with the longest term on the ladder, which often carries higher yields. Bond ladders containing noncallable bonds may be more predictable as they cannot be redeemed by the issuer prior to maturity date.*

Types of Bond Ladders:

• Check-a-Month
  Since most bonds pay income semi-annually, selecting six specific bonds that pay interest in different months can create a monthly cash flow to supplement income or provide an opportunity for reinvestment.
• Systematic Investing
  Investors who do not have sufficient funds to build a complete ladder but can save enough for a rung each year, should begin in the middle and add positions on either side in subsequent years. For long-term investors, systematic investing also provides the ability to take advantage of swings in interest rates.
• Barbell Investing
  A barbell strategy entails investing at the short and long ends of the yield curve, leaving intermediate maturities out. A barbell ladder can also contain all maturity ranges but be over-weighted on the shortest and longest maturities. This technique is generally employed by investors who expect the yield curve to flatten. Short-term investing provides liquidity and less risk as rates increase. However, when rates start to drop, the long end provides the potential for capital gains.

View sample ladder (PDF)

*Certain bonds have a call provision, which means that the issuer of the bond can repay the bond early, in which case investors would usually be faced with reinvesting their principal at lower interest rates. Investors may incur fees or transaction charges when structuring a laddered portfolio.

Bond Portfolio Evaluation & Reporting

PEARL
Exclusive evaluation and reporting for high-net-worth portfolios

Just as a shell shields a pearl, Raymond James remains dedicated to the idea that a personalized financial plan can help protect wealth throughout life’s stages. An expression of that commitment, PEARL was designed to provide personalized portfolio reporting, analysis and strategy implementation for clients with significant wealth.

This on-demand, highly customized solution combines your personal relationship with your financial advisor and the targeted expertise of our bond professionals with the tools they need to help you build and monitor assets including:

• Annual income projection and monthly breakdown;
• Maturity schedule for each bond, as well as average maturity duration;
• Portfolio duration profile chart;
• Risk and coupon rate analysis;
• Model portfolios;
• Simulated impact of varying interest rate environments;
• Assessment of hypothetical changes to your holdings;
• Anticipated call features;
• And much more.

View sample report (PDF)

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