Risk, volatility, and perceptions of strength. Another long tiresome week in capital markets where investors had to witness severe swings of positive and negative values. Volatility in capital markets is tracked by the Volatility Index.The VIX, as it is known, is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. The VIX is considered the index that predicts stock market moves. Sometimes referred to as the fear index, many investors use this volatility index to determine whether it's a good or bad time to be in the market (source: www.investmentu.com)What happens in volatile capital markets? In general, Investors may pull money from investments considered to be higher on the risk scale and reinvest, even for the short term, in assets considered less risky. Funds flows out of equity investments in the last few weeks has increased as investors have moved into money market mutual funds, short term US treasuries and other sovereign debt. According to the Investment Company Institute (August 18, Rush Out of Long-Term Mutual Funds, John Kell, Wall Street Journal), the fund liquidations (outflows) for the week ended August 10 were sharpest for United States and foreign equities.Investors, individually, it was reported reacted to the recent uncertainty in different ways. Whether the complexity of the VIX was understood or not, some individuals, retirees even, confident in their long term outlook, did not change their investment allocations.Others engaged in hedging their positions to stabilise investment positions. Short sellers increased activity during the volatility to capitalise on swings in investment values.A short sale is a technique where an investor borrows a security (or commodity futures contract) from a broker and sells it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker. Short selling (or “selling short”) is a technique used by investors who try to profit from the falling price of a stock (www.investorwords.com).With the uncertainty on the European front from various factors including the state of Greece's financial affairs, Greek securities regulators actually banned short selling on an interim basis.The US continued to take barrages of criticism regarding the sliding value of the US dollar. The Far East continued its call for a new global reserve currency, citing concerns about the ability of the US to pay its bills.After the downgrade by Standard & Poor's rating agency of US sovereign debt, other analysts cited their enthusiasm for New Zealand, Norway, and Swiss currencies, while gold continued to be perceived as an expensive alternative.Proof in the pudding. On the bond platform, however, the environment action was very different than the rhetoric concerns expressed. The US Treasury 10-year bonds that were previously priced at about 101 (that, in general terms means you paid one dollar and one cent for every one dollar you will receive at maturity on the bond), were selling for 107 (one dollar and seven cents).The US 30-year bond previously listed around 102 was selling for 112! Those Investors sought safety in droves, driving the price of these debt securities up even though they knew that no matter the coupon interest rate, if they held the bonds to maturity, they would only receive 100 (1.00 dollar) back. They paid an additional premium price of twelve cents for every one dollar of a bond purchased.The question always arises then, who would actually hold a bond for 30 years but that is the subject of an article in itself. There is safety in haircuts when the United States track record is involved.Basic bond lesson revisited. Bond prices fluctuate based upon a number of data points:l The broad interest rate in the current capital market environment that other investments (or new bonds issued) are returning.l The coupon rate that the bond will pay to the investor, no matter what the price to buy or sell stands at.l The credit quality of the bond issuer. When credit ratings are lowered on sovereign (country) debt, corporate debt, and municipalities, the price usually takes a beating as investors move to safer investments. This generally accepted market condition was contradicted when investors still flocked to buy US government debt. Safety over credit ratings?l The financial strength of the bond issuer. The credit rating of the issuer (country, corporation, municipality) may be more than acceptable, but behind the scenes the issuer may be experiencing cash flow problems. Restricted cash affects the ability of the issuer to repay interest and principal.l The availability and demand for the bond.Investors place their cash in various allocations. High return, high risk, medium returns for taking on medium risk, and low returns, in volatile environments, with low risk for safety and comfort.So, will I get my money back? Risk and volatility in investment markets relative to bonds really boil down to a simple equation. If I loan you my money (by purchasing your bonds), will I get it back: all of it with interest, most of it, some of it, or in a damaging situation none of it.Translating that into market terms, what am I willing to pay you to have the assurance that you will return my investment in full with interest when I ask for it? How credit worthy are you?Footnote. US Justice Department announced this week that it is investigating the credit rating agency, Standard & Poor's, for their role in ratings of sub-prime mortgage investment vehicles.Further thoughts. Bermuda has incurred significant debt to foreign investors due to additional recent bond issuances. Do we know what that really means down the road? How dependent are we on our credit rating if the S&P can downgrade one of the greatest safety nets on earth?Sources: Read more on the Volatility Index at investmentu.comSee also:investorwordsTo learn more about bonds, go to www.investopedia.comThe opinions in this column are the author's alone, are subject to editorial approval and are not endorsed by any organization. Information expressed in this column is general in nature and is not to be taken as specific recommendations on the purchase or sale of securities or any other investments. Individuals needing personal investment advice should seek the services of experienced independent qualified licensed investment professional advisors.Martha Myron, JP CPA CFP(USA) TEP is an international Certified Financial Planner practitioner in private wealth management. She specialises in independent fee-only cross border investment, tax, estate, and strategic retirement planning services for Bermuda residents with United States and multi-national connections, and US citizens living and working abroad. She is the Bermuda country contact at the American Citizens Abroad Tax Advisory Council (www.americansabroad.org). For more information contact mmyron@patterson-partners.com or 296-3528 at Patterson Partners Ltd.