Bonds Guide
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The document is a comprehensive guide on bond investments, explaining the basics such as what bonds are, their types (gilts and corporate), and how they are rated based on credit risk. It covers the investment strategies for bonds, including purchasing individual corporate bonds or investing in dedicated bond funds, and highlights key features like principal, maturity, coupon, yield, and credit quality. Additionally, it addresses considerations for potential investors, emphasizing the need to assess personal investment goals and risks associated with corporate bonds.
Bonds Guide
- 1. Unite Limited - Registered in Gibraltar No. 105368 – Top Floor Heritage House, 235 Main Street, Gibraltar. Tel +44 (0) 203 137 4400 – www.unite.gi Bonds Guide: Bond Investments Explained Consideredbymanytobe a vital elementinanyfinancial plan,bondscanbe usedto helpyougrow your wealth. In this bonds guide we take a look at financial bonds: explaining how bonds work; the vital factors you should considerbefore makingbondsinvestments;andstrategiestoconsiderwhenmakingbondinvestments. BondsExplained:Whatisa bond? A bond is effectively an “IOU” that is issued by a company or government in an effort to raise capital. The idea is that an investor will buy the debt and in return the issuer of the bond makes a promise to pay a set level of interest every year:plusreturningthe capital at an establisheddate inthe future. With a bond, a fixed amount is paid out: and there are two main types of bonds to choose from – gilts and corporate bonds. – Gilts: These are government bonds that are usually considered safer than corporate bonds as a government is usually less likely to default on debt or go bust. They are available as short- or long-term investments: indeed you couldevenfindgiltswithtermsof 50 years. – Corporate bonds: More speculative than gilts, corporate bonds are usually considered less risky than equities. Should a company go out of business or default on a debt then there is a risk that the investor will lose their money – however,corporate bondholdersare alsomore likelytogeta payoutcomparedto shareholders. BondsExplained:Howare bondsrated? Bonds receive grades based on their credit risk: if they are rated AAA-BB then they are considered investment-grade bonds and are usually issued by large companies and governments. Meanwhile, those rated from BB-D are consideredhighyieldbonds(alsoknownasjunkbonds),whichtypicallypayahighlevel of interest. It is possible for bond prices to vary: with investors needing to pay close attention to yields, which indicate the interest payable, expressed as an overall percentage of the price of the bond. So if you have a corporate bond valued at £1,000 paying five per cent interest over five years the yield would be five per cent. However, should the bond’s value dropto £900 thenthe yieldwouldrise to5.6 percent. Perhaps of significant importance is that bonds do not have any major association with stocks: meaning that in the eventthatequitiessink,bondvalueswillnotnecessarilybe affected. BondsExplained:Howtoinvestinbonds
- 2. Unite Limited - Registered in Gibraltar No. 105368 – Top Floor Heritage House, 235 Main Street, Gibraltar. Tel +44 (0) 203 137 4400 – www.unite.gi There are several possibilitieswhenit comestoinvestinginbonds,including: – Buying individual corporate bonds: This can be done using a stockbroker or, in some cases, you may be able to buy directly from the company. This is, however, considered to be a risky strategy because if the bond’s value were to drop or the companywere to defaultonaninterestpaymentthenthe investmentwill be rocked. Generally, this strategy was beyond most private investors: however, this changed when the Order Book for Retail Bonds was launched on the London Stock Exchange in 2011. From 2012 onwards, several companies have offered retail bonds with low investment requirements: this was done in an effort to find private investors, including ISA investors. – Dedicated bond funds: This is often a more diverse way for first-time investors to access bonds. Here it is very important to employ the services of a bond manager who can guide you on when to buy a bond. There are different types of bond funds available including those focused on high yield bonds; investment grade bonds and a combinationof the two. BondsExplained:Keybondfeatures There are some keytermsthatare importantto understandbefore investinginbonds.These include: – Principal: Refers to the amount on which an issuer will pay interest. Usually this must be repaid at the end of the term. – Maturity: An issuer has to pay a certain amount on a maturity date. If all due payments have been made then the issuer will have no additional obligations. The time until a maturity date is known as a term. Maturities can be any lengthof time:mostbondshave a termup to 30 years. – Coupon:Thisisthe interestrate thatan issuerwill paytothe holder – itis usuallyfixedforthe bond’stenure. – Yield: This is the rate of return picked up from a bond investment. It can refer to: the current/running yield, the annual interest payment divided by the existing market price; or the yield to maturity, which considers the market price and the timingof remainingpayments. – Credit quality: This reflects the probability that bondholders will receive the promised amounts on the due dates. Thisdependsona numberof factors. – Market price: Prices of tradable bonds can be influenced by a number of factors, including: currency, timing and the level of interest payments. Prices can be either “dirty” or “clean”. Dirty focuses on the present value of future cash flows with accrued interest included; whereas clean does not include this accrued interest. Generally, dirty is usedinEurope and cleaninthe USA. BondsExplained:Whattoconsider Before you invest in bonds think first about why corporate bonds are right for you. For example, are you lookingfor themto add income flow;forareturn withlowrisk;or are you lookingtodiversifyyourinvestmentportfolio? Corporate bonds are often a good feature of a diversified portfolio, particularly among cautious investors. However, they do carry the risk of capital loss so they are not a direct replacement for cash. As such, cautious investors should be careful not to holdtoomanybonds.