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Have you recently opened your brokerage statement and experienced sticker shock, especially if you own bonds? If so, I’d like to use the following example to help explain a few things about bond prices and valuations.

While generally much less volatile than bonds, determining property values in the residential real estate market is similar to determining bond valuations. Property valuation factors for your home or homes in your neighborhood include: (1) What a seller would like to receive and (2) What a buyer is willing to pay.

If you’re not planning to sell in the near future you may be concerned, but probably not directly impacted near term, by the sales price of a nearby house. Determining a home’s value is approximate until a contract to sell has been finalized between a seller and buyer.

Bond prices are also determined by what someone is willing to pay (the “bid”) and what the bond owner would like to receive (the “offer” or “ask”). The difference between the two is referred to as “the spread.” With recent significant increases in price volatility, the spread between “bids” and “asks” has increased to historically wide levels, making bond valuations less precise.

So what exactly is a bond?

For our purposes let’s stick to traditional bonds and not venture into the world of floating rate or zero coupon bonds. In the purest sense, a bond is a loan between an investor and either a corporation, government, federal agency, or other organization. The bond issuer is indebted to the bondholder. That’s why bonds may be referred to as debt instruments. The interest rate is what you receive in return. When purchasing a bond, you as the bondholder enter into a legal agreement with the bond issuer that interest will be paid to you on a regular basis. The interest rate is also called the coupon rate and is set when the bond is issued

The stated maturity date is when the face value/par value must be paid back by the issuer of the bond. The principal, or original amount loaned is returned. If certain conditions exist a bond may be called and repayment would be made prior to maturity date.

Prices of bonds

Generally bonds are issued in multiples of $1000 or par. If a bond trades above par, it’s trading at a premium and if a bond is trading below par it is at a discount. The bond’s price often fluctuates and is subject to market forces moving it above or below par.

The price of a bond could be different than its par value due to interest rate adjustments, supply and demand, whether a bond has been called or if it is likely to be (or not to be) called, changes in bond credit ratings, the creditworthiness of a bond’s issuer, changes in prevailing market interest rates, and a number of other factors.

Add to this today’s global market volatility and considerable differences may exist between where bonds are trading and values reflected on statements. In order to provide you with an independent source of valuation, some firms including Raymond James use an outside pricing service for bond positions.

In general, the pricing service uses a compilation of factors to price bonds. Under less volatile market conditions the pricing service process results in a more accurate indication of a bond’s bid price. Some of the factors used are actual trades, historical comparisons and in cases where bonds do not trade frequently, pricing models.

Today, there are additional factors that may make the evaluations more difficult and consequently the valuation pricing may be a less reliable indication of where certain bonds would trade.

Bond prices reflected on statements are best efforts estimates, useful for evaluating a portfolio and allocation mix but should not be interpreted as potential sales prices or actual “bids.” In cases where there is a need to sell a position, it is highly recommended that you contact your financial advisor to determine an actual bid.

Investors should carefully review their monthly statements and monitor changes in bond prices. However, investment decisions should not be based solely on statement pricing since prices are for evaluation purposes only, and may not be indicative of current market prices. Third party resources such asinvestinginbonds.com, as one example, may also provide comparative prices for evaluation purposes.

Prices can be affected by current market conditions, by the number of bonds, and by the formula provided by the third party, independent pricing service Raymond James and other firms may utilize for monthly statement reporting purposes.

Darcie Guerin, Financial Advisor & Branch Manager, Raymond James & Associates, Inc. located at 606 Bald Eagle Drive, Suite 401, Marco Island, and FL 34145 provides this article. If you have questions please contact Darcie Guerin via e-mail at Darcie.Guerin@RaymondJames.com. Phone (239) 389-1041, toll free (866)-343-0882 or at RaymondJames.com/Darcie. Past performance may not be indicative of future results.