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Learn about different types of bonds, the benefits and risks of bond investing. Understand the relationship between bond prices, interest rates and yields.
Some of the concepts and examples in this module are applicable only in Singapore.
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|Section 1: Introduction|
This is an intro video for Understanding Bonds
Find out more about the Institute for Financial Literacy and the complimentary talks and workshops that we offer.
In this video, we will look at what a bond is.
A Bond is a debt instrument. Let’s start with one you may be familiar with – a home loan. The banks agrees to lend you a sum of money. What are they expecting in return? The principal amount plus interest of course.
When you invest in a bond, you are lending money to a government or a corporate. The government or corporate issue bonds which represent an I OWE YOU. With you money, you purchase a bond. Now you as the lender will be expecting both principal and interest
|Lecture 4||2 pages|
This document explains about bond basics.
Using a simple illustration, if the bank lends you $80,000 for a car loan, the bank expects you to repay both the principal and interest over the period of the loan.
Bonds are normally issued by governments or corporations, and are regarded as IOUs issued by governments or corporations to raise funds. When you buy bonds, you become the lender.
Bonds are a type of fixed income securities as the debt payments of the issuers are usually fixed. Bonds potentially provide investors with two kinds of income 1) interest income, and 2) capital gains.
|Section 2: Understanding Bonds|
In this video, we look at different types of bonds.
Besides collecting taxes, governments can also issue bonds to obtain long-term financing. They are the benchmark that all other bonds issued in the country are referenced. In some countries, they are also called treasury bonds.
However some countries have at one point of time been unable to pay their creditors as promised. These countries are said to have defaulted.
This video looks at various types of bonds.
Some issuers enhance the attractiveness of the bond by giving the holder has the right to convert the bond into a predetermined number of shares of common stock of the company. Both stock and bond price can influence the price of the convertible bond.
When a bond is converted to common stock, the company’s debt is reduced as debt is converted into equity.
The Conversion can be expressed as a Ratio for example 45:1. It means that the face value can be exchanged for 45 shares. It can also be expressed as a conversion price.
|Lecture 7||7 pages|
This document details the various types of bonds available.
There are mainly two broad categories of bonds, depending on who issues the debt:
1. Government Bonds
2. Corporate Bonds
This video looks at bond risks and benefits.
In theory, in any local market, investing in government bonds may generally be considered safe. They rank above bank deposits in terms of credit quality. Corporate debt are considered safer than corporate equity in that shareholders rank behind bondholders if the company goes bankrupt. Do not assume all government debt is safe. There are countries which have defaulted on their debt obligations
With bonds, there is assurance of repayment of face value at redemption so long as the corporate does not default. In the case of shares, there is no guarantee of the price at which you can sell the shares, as this depends on their prevailing price in the market at the point of sale.
When prevailing interest rates are lower than the bond’s coupon, the bond becomes more valuable and its market price could rise above its face value allowing the bond to be sold in the secondary market for capital gains.
Generating Passive Income
You plan to increase your retirement income by an additional $250/month. You currently have $100,000 in your savings, instead of drawing down on your capital, you could consider buying a retail bond with a 10-year term-to-maturity that pays out a coupon of 3% with those savings. The bond will pay out $3,000 a year while preserving your capital of $100,000.
In some economic conditions, bond prices move inversely to stocks. While this negative correlation to stocks does not always hold true, bonds can help to reduce the overall volatility of an investment portfolio.
|Lecture 9||2 pages|
This document details the benefits and risks of bond investing.
In this video, we look at bond credit ratings.
This chart illustrates the different bond rating scales from the major rating agencies in the U.S. (Moody’s, Standard and Poor’s and Fitch
All ratings fall into two large categories known as investment and non-investment grade.
Non-investment grade bonds are also commonly known as junk bonds or high yield bonds. They offer a much higher yield to compensate for the higher probability of default. Therefore not all bonds are low risk, some may be riskier than stocks.
Credit ratings provide an avenue for the assessment of the credit worthiness of a bond issuer with respect to its bond obligations. A good credit rating can help to fetch a lower rate of interest for the issuer.
Not all bonds are rated by international or major rating agencies, as the bond issuer has to pay rating fees. It may not be cost-effective for smaller and infrequent issues meant for a domestic market which is already familiar with the issuer.
Ratings are based on information available at the time the rating is assigned, they are subject to revision or withdrawal. As an issuers’ credit worthiness can change quickly, there is no assurance that any revisions to the ratings will be made in a timely manner.
Ratings alone should not be used to decide whether the bond should be included in one’s investment portfolio.
The investor should find out more about the issuer and profitability of the business. by examining the company’s solvency ratios such as interest coverage ratios.
Further research into the track record of prior bond issues of the issuer may help in to decide, in the end, if returns are enough to compensate for the risk taken.
In this video, we look at how bond prices and interest rates are related. Also, we consider bond price volatility and bond duration.
Bond prices and interest rates move inversely.
Factors that affect interest rates will affect the price of bonds. Interest rates are in turn determined by macroeconomic factors, such as the state of the economy, inflation, unemployment, international trade, and government fiscal and monetary policies.
What happens when interest rates fall? As the coupon on the bond does not change and is relatively higher than market interest rates, more buyers will be interested in purchasing the bond, sending the bond price higher.
The reverse is true. If interest rates were to rise, this is also usually accompanied by inflation. Both these conditions cause the fixed cash flows from the bond to be less favourable to bond investors, causing the bond price to fall.
|Lecture 12||3 pages|
Follow this example in order to calculate bond yields.
You will need access to the website: http://www.sgs.gov.sg
|Lecture 13||3 pages|
This document explains the concepts of Yield Curve and Yield Spread.
In this video, we will look at various bond instruments.
There are different types of bond funds, including global bond funds, regional bond funds, country-specific bond funds, sector or industry specific bond funds, and high yield bond funds.
You may also choose to invest in bond funds through your investment-linked insurance policies.
Each has its own investment objective and a benchmark index that it targets to better, hence these funds have to be actively managed.
Investing in bond funds is usually more efficient than investing directly in the same bonds comprising the funds.
You do not need as big a capital outlay as if you were to buy all the bonds in the fund.
At the same time the basket of bonds in the fund portfolio provides immediate diversification.
The task of actively managing your bond holdings to control your portfolio’s risks and achieve desired returns is passed on to the fund managers.
But such activities attract management fees and/or other professional charges, which will reduce the overall returns to you.
In this video, we will compare between bond funds and individual bonds.
For individual bonds, Investor must be able to manage credit risks and understand yield curves. It requires more capital, time and resources to create a diversified portfolio. Corporate bonds are less liquid as interest rates rise.
For bond funds, immediate access into a variety of bonds from a small capital base. Purchase of wholesale bonds is made possible. Funds can be sold at the current market net asset value anytime.
In this video, we will look at how to read bond funds fact sheets.
Sometimes the name of the Bond Fund offers a clue to the objective of the fund. Most require a further read to understand the category of bonds the fund invests in.
Short-term or Short Duration, 3 years and below
Intermediate-term, 4-10 years
Long-term, above 10 years
The longer the duration, the more sensitive the fund is to interest rate changes. If the fund has a duration of around 10 years, movement upwards of 1% in the interest rates of the bonds in the fund would translate to a decline of about 10% in the fund’s price.
By Credit Type
Government Bonds, Investment Grade bonds and High Yield bonds represent increasing exposure to credit risk. The fund can also be a mix of various types of bonds. If so, the fund’s fact sheet will state clearly what these types are and what the fund’s investment objective is.
Country-specific bond funds may not only invest in local currency bonds, but also in foreign currency bonds. This is also true of global bond funds. Do note that such funds may be denominated in USD or currencies unrelated to those of the bonds they are invested in. Emerging Market Bonds usually involves high risk, high yield debt.
|Section 3: Conclusion|
|Lecture 17||3 pages|
Here's an activity for you to try comparing bonds.
|Quiz 1||5 questions|
This will test how well you understand the bond market available to Singapore retail investors.
Bond Basics Quiz
The MoneySENSE-Singapore Polytechnic Institute for Financial Literacy is a collaboration between MoneySENSE, the national financial education programme in Singapore and Singapore Polytechnic.
MoneySENSE is spearheaded by the public-sector Financial Education Steering Committee which comprises representatives from the Ministry of Health, Ministry of Social and Family Development, Ministry of Education, Ministry of Manpower, Central Provident Fund Board, Monetary Authority of Singapore, National Library Board and People’s Association.
Our financial education courses cover basic money management, financial planning and investment know-how.
Peggy Chan, Financial Literacy Trainer, Institute for Financial Literacy
Peggy has 8 years of experience in the financial services industry, helping clients understand their financial needs, objectives and risk tolerance as well as reviewing company policies and procedures to ensure compliance. She was also an adjunct lecturer with a Polytechnic, teaching insurance and retirement planning subjects.
Prior to joining the financial services sector, Peggy was working in the information technology sector for 13 years, first in a government agency and subsequently served as a Senior Systems Analyst in an international bank.
She is a Certified Financial Planner, which is a professional certification specific to retirement planning and wealth accumulation in addition to overall financial planning.
Peggy has a Masters of Science, majoring in Network Management. She also holds other industry certification in M5, M8, M8A, M9 and HI.