Bond Investments for the Retail Investor
Bond markets have been around for almost as long as equity markets. For most retail investors, bonds are seen as less exciting compared to equities, probably due to the relatively stable nature of bond investments. One can probably even argue that media coverage of stock markets is far more extensive than coverage of the bond markets. So what is a bond? We learn in college that a bond is a debt instrument issued by a company or a government. The buyer of the bond is in effect loaning money to the institution and is promised the full principal plus a fixed periodic payout during the tenure of the bond. The total payouts received together with the final principal will be put together in a computation to determine the yield on the bond. The yield, in layman's terms, is the effective interest rate earned on the bond for the entire duration. Some issuers issue zero-coupon bonds, which do not have any payout during the bond tenure. The investor earns the difference between the purchase price of the bond and the principal value, also known as the face value. While investment banking trading desks make profits on trading bonds on a regular basis, by taking on credit risk and interest rate duration risk, this is often not the case for the retail investor, who does not usually have the availability of live interest rate and bond trading data. A retail investor's objective in purchasing bonds can be seen as an attempt to earn a better yield compared to ordinary deposit rates. If the issuer is sufficiently creditworthy, the investor should be able to receive his or her full principal at maturity of the bond, which can have a tenure of anywhere from three months to fifteen years. At the same time, the investor may have an opportunity to make capital gains from his bond investment if the market interest rates should fall. This therefore presents an additional advantage for bond investments over ordinary deposits. Trading bonds. The bond market is still largely an over the counter market. Market participants comprise large investment banks, private banks and asset managers. Unlike stocks, which are traded on an exchange and hence have price transparency, bonds traded on the over the counter market do not exhibit this price transparency; quotes are given and taken over a platform such as Bloomberg or Reuters. With the lack of price transparency, there is also a lack of ready liquidity, as one would not be able to determine the liquidity for a particular bond issue. It can be argued that this is one of the reasons why investors are not as familiar with bonds as they are with stocks. One other way to purchase bonds would be to buy them direct from the issuer, which could be a central bank or a corporation. In most cases, the minimum investment might be higher than what most retail investors are prepared to invest in one go. With Asian central banks wishing to deepen and further develop the local currency bond markets, greater efforts in education can be seen as key to attracting retail investors towards the bond markets. Michael Russell Your Independent guide to Investing |
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