What are the factors to consider before investing in bonds?
(a) Investment objectives and timeline
Bonds are one of the instruments to diversify one’s investment portfolio. Depending on the issuer’s financial/credit standing, it can potentially be a good instrument for investment, earning regular interest income.
Customer will need to decide on his/her personal investment timeline in the selection of bonds based on the maturity dates. This affects the cash flow and the amount of risk the customer is prepared to bear. Generally, the longer the period of investment, the higher the return and risk involved. Longer tenor bonds are more sensitive to movement of interest rates and the customer who invests in these bonds may potentially make greater capital gains or losses if he/she sells off the bond investments before maturity.
(b) Features of the Bonds
There are different types and grades of bonds, from simple plain vanilla bond to those with call/put or convertible covenants.
Government or corporation that borrows by issuing bonds and repays investors with regular coupons.
Nominal value of the bonds issued or amount of money borrowed by the issuer that will be repaid to the investor upon maturity of the bond. Commonly also known as face value, or par value.
The date where the issuer must return the principal or the face value to the investor.
Interest payment made on a bond by the issuer in regular periods to repay the investor for holding the bond. Coupons are usually paid semi-annually.. For example, a $1,000 bond paying $40 a year has a coupon rate of 4.0%.
It is the annualised return earned on a bond. It is calculated by dividing the coupon rate by the price of the bond and expressed in percentage terms.
(c) Risks of investing in Bonds
Bond investment is not without risks; some of the risks are highlighted below for discussion:
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. Despite this consideration, this risk is more pertinent if the investor decides to sell the bond and not hold it to maturity
Credit risk highlights the fact that the issuer may default on payment of the coupon, and even the principal amount if the issuer has problems meeting its obligations as promised. This is also known as default risk or issuer risk.
When there is a lack of buyers or sellers in the market, the investor may not be 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.
Foreign exchange risk
The investor is exposed to fluctuations in foreign exchange rates when the investor trades in bonds that are denominated in a currency other than the functional currency of the investor. This may erode the returns on the bond investment.
Customers are advised to consider all risks by reading the prospectus/information memorandum/term sheet or seeking advice from a qualified financial adviser representative before they make a commitment to purchase any bonds.
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