Bonds

What is a bond

When you invest in bonds, you’re lending money to a company or government. In return, you get regular interest payments, called coupon payments.

Bonds are generally viewed as a defensive asset and considered to be lower risk. They are still exposed to:

• Interest rate risk – the risk that a change in interest rates could reduce the market value of the bond. If interest rates rise, bonds offering lower coupon payment rates become less attractive investments

• Credit risk – the risk that the issuer could default or go insolvent

All bonds have a set value, called ‘face value’ when first issued. If you hold the bond until maturity, you get back the face value (or principal) of the bond.

If you sell a bond before maturity, you’ll get the market value. This could be lower than the face value. Market value is influenced by:

• interest rate movements

• credit risk of the issuer

• level of liquidity, and

• when the bond is due to be paid back

How to buy and sell bonds

The main issuers of bonds in Australia are the Australian Government and corporates. Always read the financial services guide and product disclosure statement (PDS) before you invest.

Government Bonds

There are two types of Government bonds: Australian Government Bonds (AGBs) and Semi Government Bonds (Semis).

Australian Government Bonds (AGBs)

AGBs (also known as Treasury Bonds) represent sovereign debt issued by the Australian government. They guarantee a rate of return if held until maturity.

Exchanged-traded Treasury Bonds (eTBs) give fixed interest payments. Exchange-traded Treasury Indexed Bonds (eTIBs) give interest payments linked to inflation.

You can buy and sell listed AGBs on the Australian Securities Exchange (ASX) at market value. You must pay any brokerage fees.

To find out more, take the ASX online Government Bonds course.

Semi Government Bonds (Semis)

Semis represent semi sovereign debt issued by Australian states and territories. They can only be bought and sold through state and territory treasury corporations.

Corporate bonds

A corporate bond is a way for a company to raise money from investors to finance its business activities. Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market. The minimum amount required to buy corporate bonds is typically large, up to $500,000.

Consider the credit risk of corporate bonds before you buy. If the company goes out of business, you won’t get coupon payments and may not get your face value back.

Before you invest in a corporate bond

It is rare for corporate bonds to be issued to the retail market (allowing purchases below $500,000). If someone offers you a corporate bond be wary as it could be a scam.

For any corporate bond offer, check:

• Is the prospectus lodged on ASIC’s offer notice board? If not, it is likely a scam.

• Is the offer or prospectus from a legitimate source? If you’re not sure, go to the issuer’s website to download the prospectus and application form (with bank account details).

• Is the bond available to you? Some bonds, such as green bonds are not available unless purchased in a managed fund. Be cautious if someone offers you these types of investments.

Interest paid on bonds

	Interest rate	What you get	Why choose
Fixed rate bond	set when the bond is issued and stays the same until maturity	fixed coupon payments and the face value back if you hold it to maturity	a stable, regular income stream and to diversify a portfolio
Floating rate bond	can go up or down over the term of the bond. The coupon rate is based on an underlying interest rate, plus a specified percentage or margin (for example, cash rate + 2%)	coupon payments which rise if interest rates go up, but fall if interest rates go down. You get the face value back if you hold it to maturity	a stable income and protected returns if interest rates rise, as the coupon payment rate adjusts
Indexed bond	returns are indexed against the consumer price index (CPI) which protects against rising inflation	both coupon payments and the face value increase in line with changes in the CPI	indexed bonds protect against inflation (which can reduce your returns) and diversify a portfolio

How to work out the value of a bond

Yield to maturity (YTM) is a useful measure of the value of a bond. It is also a good way to compare what you’ll get by investing in different bonds.

YTM calculates the average annual return of a bond from when you buy it (at market value) until maturity. It assumes that you reinvest coupon payments in the bond at the same interest rate the bond is earning.

Make sure you always balance the return against any risks before investing.

Source:
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/investments-paying-interest/bonds

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