The BOND Market
Introduction
Bonds are investment products that can be purchased through banks and other investment outlets. I never could understand about them being different from what you could purchase through the Share Market (Equity).
We have heard about the Bulls and the Bears. We have heard that the trading price of many of the established companies tend to follow trends and several factors dictate the way the market moves. When there is a ‘bull run’ an upward trend is inevitable. So if a particular counter, say ‘Public Bank’ was trading at about RM 12, it may climb to about, say RM 13.50. Those who watch the market may find this an opportune time to sell of their share (say 1000 shares they hold). Excluding the transaction fees, one would make a tidy sum because of the difference between bought and sold price.
Bonds
The Bond Market is a different product altogether and one needs to be familiar with how it works before getting involved.
A ‘bond fund’ invests in bonds which are debt instruments. Both governments and private enterprises need money to run their ‘business’ and taking up a loan from the banks may be one of the means of raising money. But when the sum is huge it becomes difficult to easily get such loans. So what these huge companies (and governments) do is to raise the desired money through bond certificates. Investors like you may desires to lend the money for a fixed period of time ranging from a year to several years. The borrower would issue an ‘IOU’ kind of certificate to pay back the principal sum borrowed including interest that is agreed on from the beginning, say 5 % at the end of each year.
The interest the bond holder will receive at regular intervals; it is common for the issuer to pay at six month intervals, is called the ‘coupon rate’. In fact the latter term came to common use in the beginning as coupons were attached to the ‘IOU’ certificate so that they could be detached at periodic intervals and surrendered to the company for payment of interest!
Terms use in Bonds
The term ‘nominal value’ is the amount of money the issuer of the bond has agreed to pay the bond holder at the end of the maturity date (face value or par value).
Bond fund issuers would have a trustee who , remaining as a third party, has a role in ensuring the terms and conditions of the trust deed (the legal agreement giving all the details of the bond fund and the issuer’s obligation to the issuance of such bond certificates).
Unlike trading in the Stock Market (Share market), bonds are actually debt instruments and you are the creditor to the company. All returns on bonds are pre-determined. They have a maturity date so that if you intend to hold your money in bonds, you should be able to afford not needing to access this money till the maturity date.
The Stock market is different in that when you buy a stock you ‘own’ part of the company (small as it may be). Stocks are ‘equity’ and returns on the shares very much depend on how well the company is doing. You have an option of holding on the shares for as long as is allowed deriving dividends the company may declare from time to time. Market forces and the strength of the company dealings and business done all affect the price of the share. There is a risk factor involved especially in a bearish market.
Bonds generally are less risky but this again depends on how the company performs over the period of time while you wait for the maturity period. Credit risk is when the issuer fails to pay the ‘coupons’ or is unable to pay the principal sum invested. There is also what is called ‘interest rate risk’. This so called price risk or market risk may arise because or capital loss (income loss) as a result of change in level of interest rates. This would affect the bond price.
Some characteristics of Bonds
There are ratings agencies that rate the bonds issued based on the factors that may affect the value (e.g. RAM).
In the USA, Standard and Poor is one of the rating agencies who grade the Bond according to how risky it is. The following is an example
Rate | Comment |
AAA | Highest Quality |
AA | High Quality |
A | Strong |
BBB | Medium |
BB, B | Speculative (JUNK) |
BB, B | Highly speculative |
When the rating is ‘D” it is in DEFAULT.
Reading the Bond Market
It is worthwhile knowing what the tables show when you review how the bond you purchased is doing. The common way it is presented is as in the table below.
Name of Company | Coupon (Interest) | Maturity Date | Bid Price | Yield |
The coupon refers to the interest on the principal. The maturity date is the year the bond would mature. If a (c-) appears than the bond is callable; if c11 is seen, the bond is callable in 2011.
The bid prices refer to what someone is willing to pay for the bind (e.g. 94 means 94%).
The yield relates to the maturity date and not the current year.
Regulations
The Security Industry Development Corporation (Malaysia) produces little information booklets that gives information on a variety of investment products. Bonds are all approved by the Securities Commission Malaysia.
Discussion with a financial consultant would be advisable before making a decision as to what the best form of investment your ‘risk appetite’ permits. All investments have risks and the bond market is not different. Credit risk and Interest –Rate risks are thee two common ones that if often mentioned.
Conclusion.
Bonds are debt instruments. They can be purchased through banks and brokerage companies. Government bonds are the safest to purchase. High risk/high yield bonds are speculative in nature and are also called JUNK bonds.
References
A short tutorial on BONDs http://www.investopedia.com/university/bonds/bonds7.asp#axzz1gJgk0Pmx
Bond: Mission to Invest SIDC
www.sidc.com.my
Disclaimer:
The comments made here are not to be used for making decisions on any form of investment as I am not promoting any particular investment instrument. As I have said it is advisable to talk to a financial consultant before making any commitment.
Sivalingam Nalliah
12 Dec 2011
