So Many Shoes, So Little Money – Blog

Treasuries versus Bonds

August 14th, 2009

When you buy a bond, the elements I mentioned in my last post create a language which might sound/read like this: This bond has a face value of 1,000 dollars, a coupon of 6 percent, and a maturity of 10 years. The total principal of the bonds to be issued is $10,000,000.

If you bought this bond when the company originally issued it, you would pay 1,000 dollars to the company, receive a total of 60 dollars (1,000 dollars times six percent) of interest per year for the next 10 years, by check, from the company. When the bond matures, after the ten years are over, the company will send you back your 1,000 dollars. So the total amount of money you stand to earn on this bond is 600 dollars (the interest the company paid you over 10 years.) Plus, you will get your original principal back as well.

Remember how I have written about opportunity costs ?  (See May 5, 2009.) Understanding the difference in the risk/reward profile between treasuries, and bonds is an example of just how important this concept is. Let’s assume you have 1,000 dollars to invest. Which should you choose: A CD, a US treasury or a corporate bond? Since the amount of money you have available to invest is finite, you have to make your decision based upon your risk tolerance and the interest rate, and therefore the return you can expect to receive. The CD will pay the lowest interest rate, but is federally insured so you do not run any risk of losing your 1,000 dollars. The US treasury will pay more interest than the CD and is an obligation of the federal government, but it is not insured or guaranteed by anyone. So it is possible, although highly unlikely, that you could lose some of your principal if the US government decided it couldn’t pay all its debts.

The corporate bond will pay more interest than either the CD or the treasury, but is neither insured nor backed by the federal government. Instead, it is backed by an individual company, and depending upon the financial health of that company, the bond might not repaid in full when it matures. As we’ve discussed, you will get paid more interest for loaning to a borrower who is less likely to pay back the loan. The less likely the borrower is to pay you back, the riskier the loan and the higher the interest rate. So while choosing a safe low paying investment is fine, it also means you will miss out on the opportunity to earn more if you can learn to pick healthy borrowers who pay a higher interest rate.

For now, know that bonds, whether from the US government or a company, are a sensible and versatile alternative for the beginning investor. Like flats, they can make almost any outfit look good and ensure comfortable feet!

Fashionista Fact:

In the United States, women spend approximately two billion a year to make their feet more comfortable from surgery correcting problems generated by tight-fitting shoes and bunions. There is even a treatment to help make high heels more comfortable which combats pain by injecting collagen or DermaFiller into the fat pad in the ball of the foot.

Generally, the higher the heel, the higher the risk for future foot problems. Comfort offers a lower return, while the return from style is much higher. But remember there is an opportunity cost!

Filed under: Investing

Tags: Investing