You buy a corporate bond at par or at a discount, right? It just seems like common sense. What would lead you to purchase a corporate bond at a premium? Actually, investors do sometimes buy fixed-income securities with coupon rates above current market rates. If interest rates are on the way up, buying a premium bond when interest rates are still relatively low represents a defensive play. The move does involve risk, however.
Bond investors have reason to be frustrated. As it is, they are willing to accept a lower total return than stock market investors by choosing safety and security over risk and return. The Fed has basically punished fixed income investors by keeping interest rates extremely low for a long time. The result is that you can’t simply pull a list of AAA government bonds, go out a few years, and expect a 5% yield to maturity. No sir, not anymore. What you can expect is something closer to 2%, or perhaps less. The more safety you require (think: treasury bonds) the less yield you can expect. I’m finding a great deal of difficulty building a bond portfolio these days which satisfies my bond investors in terms of risk, duration, and yield. The problem is that when I finally create a portfolio with a yield averaging 4%, I find my client is either taking on too much risk, or going out so far that they are locking in rates which they are soon to regret. So what are bond investors to do?