Understanding Bonds, ETFs, and the 1929 Stock Market Crash
Understanding Bonds and ETFs
Bond Fundamentals
Bonds Above Par: A bond sold on the secondary market with a market value higher than its face value.
Bonds Below Par: A bond with a market value below its face value.
Bonds vs. Certificates of Deposit: Both bonds and certificates of deposit (CDs) pay investors interest over the contract’s life. However, bonds are debt instruments, whereas CDs are savings certificates.
Corporate Bonds: These bonds typically offer higher yields due to the higher risk involved.
Coupon: The interest paid to the investor in exchange for the loan is known as the bond’s coupon.
Debt Investment/Bond: An investor lends money to an entity (corporate or governmental) that borrows the funds for a defined period at a fixed interest rate. Companies, municipalities, states, and the US and foreign governments use bonds to finance various projects and activities.
Maturity: Bonds are issued for a specific period, known as maturity. At maturity, the bond issuer repays the loan to the investor.
Municipal Bonds (Munis): Their primary advantage is that returns are often free from federal tax. Some local governments also make their debt non-taxable for residents, making some municipal bonds entirely tax-free. Due to tax savings, the yield on a muni is usually lower than that of a taxable bond. However, this can be an excellent investment for individuals in high tax brackets.
Exchange-Traded Funds (ETFs)
Exchange-Traded Fund: An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.
Two Types of ETFs
- Leveraged ETFs: Seek to gain a multiple return of the underlying asset.
- Inverse ETFs: Track the opposite return of the underlying assets.
Advantages of an ETF
- Lower expense ratios compared to the average mutual fund.
- Commissions are the same as regular stock orders.
- Diversification similar to an index fund.
- Ability to sell short, buy on margin, and purchase as little as one share.
- Potential for favorable taxation on cash flows.
The Wall Street Crash of 1929
The Wall Street Crash of 1929, also known as the Stock Market Crash of 1929 or the Great Crash, was a major stock market crash that occurred in late October 1929. On March 25, 1929, the stock market corrected and began to fall. Margin calls were made, and investors initially panicked. Other warning signs appeared but were largely ignored. On October 29, Black Tuesday hit Wall Street as investors traded millions of shares on the New York Stock Exchange in a single day. Billions of dollars were lost, wiping out thousands of investors. In the aftermath of Black Tuesday, America and the rest of the industrialized world spiraled downward into the Great Depression (1929-39), the deepest and longest-lasting economic downturn in the history of the Western industrialized world up to that time.
During the 1920s, the US stock market underwent rapid expansion, reaching its peak in August 1929 after a period of wild speculation. By then, production had already declined, and unemployment had risen, leaving stocks in great excess of their real value. Among the other causes of the eventual market collapse were low wages, the proliferation of debt, a struggling agricultural sector, and an excess of large bank loans that could not be liquidated.
The stock market crash of 1929 was not the sole cause of the Great Depression, but it did accelerate the global economic collapse, of which it was also a symptom. By 1933, nearly half of America’s banks had failed, and unemployment was approaching 15 million people.