Understanding the Risk in Bonds

With a wide variety of ways to analyze bonds, it may make your head spin. Even so, assessing the potential risk just before you acquire and also determining your possible returns is an essential step in the procedure of acquiring bonds.

1. Examine All Potential Risks


You should take note of all the information – interest rates, inflation, just how simple it is to offer that certain bond, you name it.

2. Credit Risks

It doesn’t matter exactly what kind of bond you decide on to invest in, there is consistently a credit history danger. In 1995, U.S. Treasuries, thought about the gold criterion of bonds were close to default for the initial time in past.

3. Bond Evaluation Checklist


– What is your earning capacity?
– What is the outstanding debt?
– What is a typical divident repayment?
– What is the existing profits per share?
– What forseeable technological adjustments might impact this bond?
– What is the track record of administration?


4. Returns

As financial obligation lots grow, the amount of passion paid increases, lowering the quantity for such financial investments along with bringing a firm closer to default on existing debt, since simply a lot can be sustained by present profits.

5. Rate of interest

A huge number of bond issues have maturations with 5-30 year periods. Any sort of adjustment in the prevailing interest prices impacts unmatured bonds in two ways.

7. Handling Inflation

Rising cost of living is the adversary of bonds. It will considerably lessen your return on any kind of bond. Also ignoring tax concerns, an 8 % bond in a 4 % inflation atmosphere deserves half its coupon value. Historically, rising cost of living has the tendency to boost greater than it minimizes. Getting worse returns for all financial investments when it does minimize the basic economy usually tends to experience. Know the price of inflation and the marketplace conditions before you invest.

Desperate Times

Desperate Times mean Desperate Measure

You know what they say about  desperate times mean desperate measure, right?  Well, the City of Kilgore has recently faced this situation and gone ahead and decided that they desperate measures was the right thing to do.

In an article posted on Satuday, the News-Journal of Longview, Texas reported that the city of Kilgore was “pulling out all the stops to lower the cost on a proposed baseball complex after several bids to construct the facility came in over budget.”

Here, the City of Kilgore decided to have a new baseball complex built.  So, like any good city would do, they came up with plans for the complex and then went and got some bids for the complex.  As a part of the bid process, they required that the construction firms post a bid bond, which would then turn into a performance bond once the project was awarded.  Further, they required a bond for each stage of the construction and by each contractor.

What’s the Problem?

The problem is that the bids that they received were greater than the budget that they constructed.  Thus, the budget was not enough to cover the costs of the baseball complex.

Now, here’s where it gets good.  Most cities would then take a look at the complex and determine whether it was truly necessary or whether it could be scaled back to meet the budget.  But not Kilgore.  Instead, they decided to “think outside the box.”

What are some Solutions?

The City of Kilgore is deciding whether to serve as its own general contractor.  That is, they believe that they can hire quality subcontractors for each phase of the construction and properly manage their work, including quality controls, overages, timeliness, etc.

The next solution that they came up is really the brilliant one (sarcastically said).  They want to eliminate the bond requirement as the City of Kilgore believes that there are many contractors out there that cannot bid on governmental projects as they cannot get a bond.  So, by waiving the bond requirement the City of Kilgore can get more bidders.

So what’s the problem with waiving the bond requirements?

This does, of course, completely ignore risk and quality.  Here is what I mean.  If a contractor is not qualified to get a bond, that means that the contractor is riskier, whether due to a poor financial condition, lack of liquidity, a recent bankruptcy, or other problem that would keep them from getting a bond.

By opening up the bids to these contractors, the City of Kilgore is essentially saying a couple of things: 1) quality is not really all that important.  We want the job done for the cheapest cost that we can get; and 2) risk is not considered as a part of this process.

I contacted a bond company, Swiftbonds.com (found them through wikipedia) and asked them about the baseball complex.  They responded “this is a pretty rate situation, but it does happen.  In these cases, the municipality is really take a large gamble that the project will be completed on time, done right without having any defaults.  In our experience, this would be extremely rare.  We would guess that the City of Kilgore will regret this decision.”


Although it is great to think outside of the box, it isn’t great to start thinking that you are smarter than everyone else.  Thus, when the City of Kilgore didn’t get bids for their baseball complex that fit within their budget, they decided to increase the risk by waiving their bond requirements.  This desperately measure is very likely to cost them more in the long run.