Learning About Bonds
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A bond is a debt investment, where the investors lend money to an entity, typically corporate or government. In return, the bond issuer will pay the bondholder interest known as coupon (A variable or fixed interest rate which the Issuer pays for borrowing the funds for a defined period of time). On maturity date, the date of which repayment was agreed on; the investor will get back the borrowed amount, also known as face value, par value or principal amount.
A bond is made up of few main components: principal/face value, the coupon rate and maturity date
Principal amount: The amount that the investors lend to the bond issuer.
Coupon Rate: The coupon is the amount the bondholder will receive as interest payments. Most bonds pay out interest every six months, but it's also possible for the interest pay out to be set as monthly, quarterly or annually. The coupon is expressed as a percentage of the principal/face value. If a bond pays a coupon of 5% and its principal/face value is $1,000, the interest pay-out will be $50 per year.
Maturity Date: The maturity date is the date on which the investors will get back the Principal Amount.
- Angel Bonds
- Angel bonds are investment-grade bonds, bonds which have credit rating of Baa3 to Aaa (Moodys), BBB- to AAA (S&P) or BBB- to Aaa (Fitch) and normally offer a lower interest rate because of the high credit rating. If the company's ability to pay back the bond's principal is reduced, the bond rating may fall below investment-grade minimums and become a ‘fallen angel’.
- Callable Bonds
- Callable bonds can be redeemed by the issuer prior to maturity. The main reason of a call is a decline in interest rates. If interest rates have declined since a company first issued, they would likely want to refinance this debt at a lower rate. In this case, the company will call its current bonds and reissue new, lower-interest bonds.
- Corporate Bonds
- Corporate bonds are issued by corporations. Generally, a short-term corporate bond has a maturity of less than five years, intermediate is five to 12 years and long term is more than 12 years.
- High-yield Bonds
- A high-yield bond, also known as a "junk bond" is a bond rated below Ba1 (Moodys), BB+ (S&P) or BB+ (Fitch) because of its high default risk. As the name suggests, high-yield bonds typically offer interest rates higher than investment grade bonds.
- Perpetual Bonds
- Bonds that have no maturity date. Normally, they will have a call date.
Bonds that are listed and investors are able to buy/sell on the exchange. They are normally traded in a smaller size as compare to the Over-The-Counter (OTC) bonds. However, prices quoted on the exchange are ‘dirty’ prices (including accrued interest) whereas for OTC bonds, prices are normally quoted as ‘clean’ prices. If you have a Phillip Trading Account, you may login to POEMS 2.0 Trading Platform to buy exchange traded bonds.
Seniority refers to the order of repayment in the event of a sale or bankruptcy of the issuer. Senior bond will have their first claims on the remaining asset as compared to junior (subordination) bonds. “pari passu” is normally used to describe the equal debt ranking of the new senior bonds issuance versus other senior bonds of a company.
Debt covenants are promises made by the issuer not to engage in certain actions which normally cover a wide range of parameters. Some common debt covenants are debt ratios, ownership of the company and liquidity.
Keepwell agreements is usually an agreement between the parent company and the subsidiary (which is the issuer), where the parent company agrees to keep the issuing subsidiary in good financial healthy, by maintaining certain financial ratios.
A generic covenant stating that the bondholder has the right to "put" the bond back to the company if there is a "change of control" event. Investor should also find out the terms and conditions of the specific bond on what constitute a change in control.
- Credit risk
- Credit risk is the risk of payment default of the coupon, and even the principal amount if the issuer has problems meeting its contractual obligations. This is also known as default risk or issuer risk.
- Foreign exchange risk
- Foreign exchange risk is the risk investors are exposed to when they trade in bonds that are denominated in a currency other than the functional currency of the investor caused by fluctuations in foreign exchange rates. This may erode the returns on the bond investment.
- Liquidity risk
- Liquidity risk is the risk of having a lack of buyers or sellers in the market, which may lead to the investor not being able to execute the trade or may be forced to trade at a value significantly away from the investor’s desired price. This can be deemed as liquidity risk.
- Market risk
- The value of the bond is subjected to interest rate changes, as well as demand and supply forces. Bonds, in particular, are sensitive to interest rate fluctuations and the prices of bonds move in opposite direction with interest rates. However, this risk is more pertinent if the investor decides not to hold the bond to maturity. Bonds may be packaged with guarantee security.
Common Terms used in the bond Investment:
|Angel Bonds||Bonds which have credit rating of either Baa3 to Aaa (Moodys), BBB- to AAA (S&P) or BBB- to Aaa (Fitch), or known as Investment grade bonds|
|Ask price||Price which investor acquire the bonds|
|Ask Yield||Yield that the investor received at the price that they invest in the bonds|
|Bid Price||Price which client is able to sell the bonds|
Date where the issuer is able to call back the bonds in part or in full
|Change of Control||
A type of bond covenant which gives the bondholder the right to sell back the bonds to the company at a certain price when there is a change in ownership
|Credit Rating||The credit worthiness of corporate bonds, normally done by the credit rating companies|
The failure or inability of an issuer to pay coupons and/or bond principal.
|Discount||Purchasing the bond at a price less than the face value.|
|Face Value||The nominal value or the dollar value that the investor received at maturity. However, the nominal value might not be the price the investor has to pay|
|Investment-Grade||Bonds which have credit rating of either Baa3 to Aaa (Moodys), BBB- to AAA (S&P) or BBB- to Aaa (Fitch)|
|Junk Bonds||Bonds which have credit rating below Ba1 (Moodys), BB+ (S&P) or BB+ (Fitch)|
|Premium||Buying a bond at price higher than the face value|
|Price||The price paid to buy/sell a bond, normally expressed as a percentage to the face value|
|Principal||The nominal value or the dollar value that the investor received at maturity. However, the nominal value might not be the price the investor pays|
|Re-Fix coupon rate feature||A special feature of some bonds, which allow their coupon rate to be re-fixed in the future|
|Yield||The annualised return the investor expects to receive from investing in a bond. A simple formula would be yield = coupon rate/price|
|Yield to Maturity (YTM)||
The annualised return the investor expects to receive from investing in a bond when they hold to maturity
|Yield to Next Call (YTNC)||The annualised return the investor expects to receive from investing in a bond when the bond is called back by the issuer|
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