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Liquidity Rating

Summary:

Computed daily as a ratio based on the number of trades in a given bond compared to the average number of trades of all the bonds in a similar class. The higher the ratio, the more frequently the bond is traded relative to similar bonds. The range covers the last 30 days. Liquidity is considered a reliable investment factor because it helps indicate if a bond purchased today is likely to have a liquid market available to be sold into at some future date. For example, if an investor's financial situation changes and needs to convert bonds to cash, or if an investor rebalances a portfolio and there is a need to replace an asset with another one that better meets the objectives.

Bonds are rated from one to five stars based on how their liquidity ratios compare to the ratios of bonds in the same equivalency class. The higher the ratio of a bond relative to other bonds in the same class, the more stars it receives.

The liquidity rating, along with BondView’s additional ratings criteria, provide a compass to help investors come to their own conclusions prior to making bond investments.

Volatility Rating	Explanation
5 Stars	Highest liquidity group in Equivalency Class 80% to 100%. Excellent opportunity.
4 Stars	Next highest liquidity group in Equivalency Class 60% to 80%. Good opportunity.
3 Stars	Third highest yield group in Equivalency Class 40% to 60%. Neutral opportunity.
2 Star	Fourth highest liquidity group in Equivalency Class 20% to 40%. Poor opportunity.
1 Star	Lowest liquidity group in Equivalency Class 0% to 20%.

More Information:

Volatility Risk is the exposure of a bond to the volatility of fluctuating interest rates. Changes in interest rates affect the values of investors’ bond holdings, as rates rise bond pricing falls, and vice-versa. This risk is measured using duration, which is the average time, in years, for an investor to be repaid the price of a bond by the bond's cash flow, including coupon payments and the payment of the principal at maturity (or call date). The longer the duration, the greater is the investor's risk exposure.

Bonds are rated from one to five stars based on how their durations compare to the duration of bonds in the same equivalency class. The lower the duration of a bond relative to other bonds in the same equivalency class, the more stars it will receive. Duration is the time it takes for an investor to be repaid the price for a bond by the bond's total cash flows.

For example, suppose the current price of a bond is $970, maturity is in three years, the annual coupon payment is $50, and the current market interest rate is 7%. The present worth of the coupon payments and payment of the $1,000 principal is $2,686.23. The duration, calculated by dividing the present worth by the current price is: $2,686.23 / $970 = 2.77 years

Bonds that pay coupon interest will always have a duration less than maturity. Zero coupon bonds, with no coupon payments, have a duration equal to maturity. Using duration, it's possible to approximate how much a bond's price is likely to rise or fall when interest rates change. As interest rates increase, a bond's price decreases. Duration measures how quickly a bond will repay its price. The longer it takes, the greater exposure the bond has to changes in the interest rate environment.

Therefore, the longer the duration, the higher is the interest rate risk (as opposed to default risk).

Here are some of factors that affect a bond's duration:

Time to maturity: Consider two bonds that each cost $1,000 and yield 5%. A bond that matures in one year would more quickly repay its true cost than a bond that matures in 10 years. As a result, the shorter-maturity bond would have a lower duration and less risk. The longer the maturity, the higher the duration, and the greater the interest rate risk.

Coupon rate: A bond's payment is a key factor in calculating duration. If two otherwise identical bonds pay different coupons, the bond with the higher coupon will pay back its original cost quicker than the lower-yielding bond. The higher the coupon, the lower the duration, and the lower the interest rate risk.

Knowing the duration of a bond, or a portfolio of bonds, gives an investor an advantage in two important ways:

Speculating on interest rates: Investors who anticipate a decline in market interest rates, as a result of, for instance, a stimulative rate cut by the Federal Reserve, would try to increase the average duration of their bond portfolio. Likewise, investors who expect the Fed to raise interest rates would want to lower their average duration.

Matching bond selection to your risk: When selecting from bonds of different maturities and yields, duration allows you to quickly determine which bonds are more sensitive to changes in market interest rates, and to what degree.