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Market liquidity issues could create profit opportunities

10/01/2015 01:01PM ● Published by Katelyn Nelson

There have been several articles in the news lately about a lack of liquidity in the bond market. What does this mean, and what opportunities might it present to the savvy investor?

First, what is a bond? A bond is simply a promise to pay principal and interest on a loan. You can “own” a bond, just like a bank might “own” your mortgage note. When you own a bond, you own the rights to receive the principal and interest payments, just as a bank does on a mortgage note. This is subject to the ability of the issuer to make those payments. There are many variations of the dollar amounts and payment terms that different bonds have. When you own a bond, you can sell your rights to the payments and receive the market price for the
bond.

Market liquidity is basically the ability to buy or sell an investment, such as a bond, quickly and without affecting the price. In a highly liquid market, there are many buyers and sellers. You would be able to buy or sell a reasonably large amount of investments quickly without significantly changing the price of the investment. In an illiquid market, there are fewer buyers and sellers. Buying could cause the price to increase, and selling could cause it to decrease. It could also take more time than usual to sell.

As I mentioned in a recent article, one characteristic of bonds is that when interest rates rise, the price of some bonds fall. In an illiquid market, an increase in rates might cause a larger drop in prices than would normally occur in a liquid market. For those who hold bonds, this could present significant risk. For those who are waiting to buy, this could present more of a buying opportunity than usual. Be sure to evaluate all of the potential risks and benefits of the particular situation. Keep in mind that a lack of market liquidity can involve significant risk
and could cause difficulty when selling the bond prior to maturity. Other issues to consider in such a decision are whether or not prices could fall further, rates of return on the bond and other investments, credit quality of the bond issuer, the timing of your cash needs, your
need for liquidity, as well as other variables.

A lack of liquidity can be a problem for some, but can present profit opportunities as well. It is
a matter of understanding and evaluating the potential risks and rewards. As always, consult with a Certified Financial Planner professional (CFP®) when making investment and financial decisions.

October is National Bullying Prevention Month. Food for thought… A bully is a coward with
power. Take away his or her power, and there is not much left.

All the best to you!
Steve Ciaccio, MBA, CPA, CERTIFIED
FINANCIAL PLANNER™ is the founder of Ciaccio Wealth Management, located at 232 S. Batavia Ave., Batavia. He can be reached at 630-454-4599. The opinions voiced in this article are for general information only and are not intended to provide specific investment or tax advice or recommendations for any individual. Securities and advisory services offered through LPL Financial, a Registered Investment Advisor.
Member FINRA/SIPC.
Copyright Steve Ciaccio 2015
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