Disclaimer: This article was curated as part of a sponsorship agreement with Bondsupermart in conjunction with MYFS.
If this were an exam, the answer would be “A fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or government) (Fernando, 2021).
To illustrate it with an example:
Let’s say company A wants to raise funds. They could issue bonds, and if investors deem it attractive, they will hold the bond.
What do investors get when they hold a bond? Well, year to year, they may receive “coupon payments” for holding the bond, and at the end of the maturity period, they receive the payment in full.
Face Value: RM1000
Coupon Rate: 5%
Coupon Payment Frequency: Yearly
Time to maturity: 3 years
You initially lend RM1000 to the company, and every year for 3 years, you get 5% (which is RM50). At the end of the 3 years, you not only will get the RM1000 back but you’ve also received another RM150.
There are more complex things to consider, such as the “present value of a coupon” and the risks involved. There is always a chance that the company (or country, in the case of Greece) will be unable to repay you.
Some key terms involved with bonds:
Principal: How much the issuer will pay the lender of the bond at expiration, also called a fixed value.
Covenant: legally binding, agreed on by lenders to protect themselves if the bond issuer fails to meet the obligations.
For other commonly used terms and jargons, you may read this article or visit Bondsupermart’s dedicated bond basics page for more information.
The history of bonds
While the modern-day bond seen in financial markets today did not emerge until the 1700s, the first “debt” and contract of sorts can be traced back to present-day Iraq in 2400 BC (which would be 4422 years ago) (Cummans, 2014).
(Image Source : Bondfunds.com)
The above is a picture of the stone. The terms in question were guaranteed payment of grain, and the surety guaranteed the principal if payment failed.
Bonds can be issued not only by corporations but also by governments. The Bank Of England created the first government bonds in 1693 to raise funds for a war against France (Cummans, 2014). In The First Avenger (2011), you may remember Captain America mobilising the public and driving demand for government bonds by putting on various entertainment shows.
(Copyright of Marvel Studios)
Have you wondered what the world would be like without bonds? Hear this podcast as Senior Fixed Income Analyst Dexter Tan from iFAST Singapore discusses the origins of bonds, if there is a need for this asset class, and dive deep into the questions you may have about why bonds exist.
How do you calculate bond prices and trade them?
It is far easier to determine a bond’s present value than stocks. If we return to our previous example
Face Value: RM1000
Coupon Rate: 5%
Coupon Payment Frequency: Yearly
Time to maturity: 3 years
1000 / (1 + 0.05) ^ 3 = Present Value
If I were to purchase the bond right now at par, with three years to maturity, its present value would be $863.84
Bonds, like stocks, can be traded on the open market, but you may pay a higher price due to a premium.
Like stocks, bonds can trade for below or above their “fair value.” For one, bonds may fall in price or desirability due to interest rates/Overnight Policy Rate (OPR) rises. However, bond issuers make the promise to pay investors the face value at the bond’s maturity date. While there are companies that fail to do so, the likelihood of default in payment is typically low for financially stable corporations and agencies.
Bonds can also fall in price if there is an increased perceived risk among the public associated with the bonds. For instance, take Serba Dinamik, an energy services group in the Oil & Gas, petrochemical, power generation industries, water & wastewater, and utility industry.
Serba Dinamik is currently being sued by the Securities Commission for “submitting false statements,” and its stock is currently suspended after failing to meet its Sukuk payment of $222 Million to the holders (Reuters, 2021). As a result, market participants are concerned that they will default on further bond payments, hence a fall in the bond price.
(Source : Bondsupermart, SDHMK 6.300% 09May2022 Corp (USD)
Calculations are made easier with Bondsupermart’s Bond Calculator, due to it taking into account figures like accrued interest. If you purchase the bond at a price of 13.401 USD with a settlement date of 12 Jan 2022, the total payment would amount to USD29,007.
Assuming things go smoothly and the company fulfills its financial obligations, you can receive an annual coupon of USD 12,600 on top of USD 200,000 when the bond expires, which would be a nearly 690% return on your investment. However, after failing to meet it’s previous sukuk payment, investors may feel less confident that their financial obligations would be fulfilled.
Where do bonds fit into a portfolio?
Bonds offer investors a fixed rate of interest so investors can better estimate their returns before investing in a bond. This is in contrast to stocks, which typically do not offer such predictability. The principal amount and annual coupons should theoretically be paid regardless of how the value of the bond fluctuates. It is important to note that a company could possibly default or file for bankruptcy resulting in a loss of investment sum for investors in reality. Despite this, investors can limit their risk by researching a company’s bond rating to gauge if the company can repay its debt. Such ratings are clearly indicated in Bondsupermart’s bond factsheet.
Or consider this scenario: suppose you are well versed with the company but rather not hold a stake in its growth. But, you feel confident they can meet the repayment and think that the bond is trading at a fair value. In that case, individual investors can choose to add these fixed income instruments to their portfolios.
If you would like to explore bonds further, check out Bondsupermart’s website (https://www.bondsupermart.com/bsm/home), where you can explore the bond market or read up on insights in the bond world.
For bond-related news within your fingertips, follow Bondsupermart on their socials – Telegram, Facebook, and Twitter!
References:
Reuters. 2021. Malaysian securities regulator charges Serba Dinamik, seeks arrest of CEO. [online] Available at: <https://www.reuters.com/business/aerospace-defense/malaysian-securities-regulator-charges-serba-dinamik-seeks-arrest-ceo-2021-12-29/> [Accessed 4 January 2022].
Fernando, J., 2021. What Is a Bond?. [online] Investopedia. Available at: <https://www.investopedia.com/terms/b/bond.asp> [Accessed 4 January 2022].
Cummans, J., 2014. BondFunds.com. [online] BondFunds.com. Available at: <http://bondfunds.com/education/a-brief-history-of-bond-investing/> [Accessed 4 January 2022].
Serba Dinamik SDHMK 6.300% 09May2022 Corp (USD) factsheet : https://www.bondsupermart.com/bsm/bond-factsheet/XS1900582476
Researcher: Muhammad Bahari
Editor: Natalie Eng
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