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With the well known history of volatility in silver prices, it is only natural that questions arise about the sustainability of today’s silver market. In just the past 18 months, we have seen the price of silver increase from $14.87 per ounce in August 2009 to $40.42 per ounce in April 2011. While there are many solid reasons to believe that silver will rise in value, investors must be mindful of the volatile price movements of this precious metal. In the past, investors used silver bonds to reduce their risk of exposure to shifting silver prices.

What are Silver Bonds?

Although silver bonds have not been issued on over 26 years, they could be popular among risk-averse investors who wish to benefit from the high silver prices of today while managing and wild moves in silver price.

A silver index bond is quite similar to normal bonds that are traded on the major exchanges every day. They are purchased for an initial amount of money, sometimes referred to as the principle or capital, with interest paid on a pre-determined basis until that bond reaches a certain maturity date.

However, this type of bond differs from traditional bonds as they contain an option allowing the holder the ability to change the bond into a specified amount of silver or an equal amount of cash provided certain conditions are met.

How Do Silver Bonds Work?

A real life example would be the Sunshine Mining and Refining Company bonds, which were last issued in 1985. The Sunshine Mine in Idaho was a prolific silver producer since the mine opened in 1904. In April 1980, the company would issue the first silver indexed bonds.

The first bonds were sold at $1,000 each, with an annual rate of interest of 8.5% and a maturity date of 1995. Each of the bonds had the option of being exchanged for 50 ounces of silver. To equal the valuation of the bonds, Sunshine priced silver at the time of the issue at $20 per ounce.

If silver prices doubled to $40 per ounce, the value of the bond would increase to $2,000, and it could be sold in the marketplace just as any other equity. But the bond holder could also keep the bond until the maturation date, collecting the initial principal along with all of the interest payments.

Unfortunately for Sunshine, silver prices collapsed after 1980, sending the price of silver to $4 per ounce and ushering in a bear market for silver that would last 25 years. For those investors willing to continue holding Sunshine bonds, they could simply wait until maturity date. But the crushing silver bear market placed incredible financial strain on the company, and in 1991 they defaulted on their silver bonds.

Every asset carries risks and rewards. With silver demand at highs not seen since 1980, many new silver investors are entering the market. Be sure to sign up for your free silver investment kit from David Morgan. It is filled with unique insight into silver prices, silver investment products, as well as information on silver producers and silver mining stocks.