The key thing to remember is that wherever you decide to invest your money, there is always risk involved. You just need to make sure you get paid for the risk with your returns.
Generally, equities (shares/stocks) are high risk, high return, term deposits are low risk low return, and fixed income investments like bonds sit somewhere in between.
As a defensive asset class, bonds and fixed income investments are lower risk in comparison to other investments (like equities). They’re also typically lower yield, but bond yields are rising in response to the recent RBA rate hikes.
No matter which type of investment you choose, it’s essential to read the Information Memorandum (IM) document or product disclosure statement (PDS), and seek professional financial advice, before signing on the dotted line.
Ready to dive into the world of fixed income and bonds?
- What are bonds, and how do they work?
- Can you sell a bond before the maturity date?
- Types of Bonds & Debt Securities in Australia
- Types of interest on bonds
- How to buy bonds in Australia
- What affects the price of bonds?
- How to make money from bonds
- Three advantages of bonds
- The disadvantages of bonds
- Are bonds a good investment?
- Thinking of investing?
Australian Government (Treasury) Bonds
Australian Securities Exchange (Stock Exchange). A marketplace for the trading of stocks/shares/equities (ownership) of listed companies.
Coupon rate/ Interest rate
A percentage of the face value of a bond or fixed income product, paid from the date of issue until maturity.
Exchange-traded Australian Government Bonds
The principal value on which coupon interest payments are calculated.
The seller/borrower/debtor (typically a company or government).
The buyer/lender/creditor/bond holder/ security holder
The date on which the bond or fixed income product is due to be repaid.
The Reserve Bank of Australia (RBA) is the central bank of Australia, and controls monetary policy including the Cash Rate Target.
The annual rate of return on a bond or fixed income product.
What are bonds?
When the government, or a company, needs capital, it can issue debt securities (like bonds) to raise the necessary funds.
When you buy a bond, fixed income products or hybrid securities, you’re lending the issuer (a business or a government) money. They then agree to pay you interest in return for the loan, until the maturity date.
Bonds typically offer fixed rates of interest, with semi-annual or quarterly payments, and are seen as “defensive” assets due to the lower risk attached.
Learn more about the bond basics here.
How do bonds work?
Bonds work in a similar fashion to a loan, in that the higher the risk (the more doubt there is that the issuer can repay the debt), the more the company/government must pay in interest (the coupon rate) to bond holders/ security holders.
Can you sell a bond before the maturity date?
Selling a fixed income product or bond before it reaches the maturity date (matures) means you’ll get market value, instead of face value.
Market value can be lower or higher than face value and is influenced by:
- Credit risk of the issuer
- Level of liquidity
- Interest rate movements
- Maturity Date
Types of Bonds & Debt Securities in Australia
There are only two types of bonds you can buy in Australia, but many different types of debt securities that also offer stable returns.
What are the different types of bonds and fixed income investments?
A government or treasury bond refers specifically to a bond (that acts as a loan) issued by governments. As a highly secure investment product, second only to cash at the bottom of the risk spectrum, they have very low-risk attached and low but predictable yields.
A corporate bond is a bond issued by a corporation or private company (that acts as a loan). These bonds are riskier than government bonds, which means they generally pay a higher rate of interest.
There are many other fixed income products (securities) that act in a similar fashion to bonds, in that they provide predictable coupon payments and a set maturity date.
Market-linked securities, hybrid securities and bond-linked securities are just a few examples of other fixed income instruments.
How do corporate bonds work?
Corporate bonds are issued by private organisations who are looking for capital or funding.
These fixed income products can be bought either on the primary market or the secondary market.
Typically, bonds are issued when companies need more money than banks are able to lend. They do this through a process called ‘bond issuance’.
For example, a company issues $100 million in bonds, each with a coupon rate of 6% and a face value of $10,000. These bonds are offered to investors to raise the $100 million that the company needs to fund their venture, split across multiple investors (creditors).
Corporate bonds vary in terms and creditworthiness, so you must understand the issuer’s creditworthiness and read their information memorandum, prospectus and/or annual report.
The interest payment on a corporate bond (known as a coupon rate) is usually higher than on government bonds because of the higher default risk.
Types of Interest on Bonds
The type of bond issued impacts the amount of interest paid to creditors (bond holders, security holders or investors).
There are three main types of bonds, each slightly different due to their relationship with the Reserve Bank of Australia (RBA) Cash Rate rates and inflation.
These fixed income products have a set interest rate (coupon rate) from when the bond is issued to the maturity date. On issuing the bond, companies will review current inflation and cash rates to determine the coupon rate.
Bond Prices: How To Buy Bonds In Australia
There are several options for investing in bonds in Australia:
Most bonds are not publicly traded, which means they’re not available to retail investors with less than say, $500,000 to invest.
Instead, these bonds are sold ‘over the counter’ in the secondary market (also known as the OTC market) to wholesale investors.
Bonds sold in the primary market (wholesale market) not only have a significant minimum investment amount (think $500,000 and up), every day Australians do not have access.
If you are not a broker, you will need a broker to execute your trades for you.
What Affects Bond Prices?
Two major factors cause bonds prices to fluctuate, interest rates and risk.
Bond prices (not to be confused with bond yields) have an inverse relationship with both interest rates and risk. That means, as one goes up the other goes down.
If the issuer’s credit rating is high or improves, it is more likely that the issuer will be able to make the required interest payments on the bond. As such, the credit risk of issuers can have a substantila impact on how bonds are priced.
If an issuer has a low credit risk, and is more likely to repay the debt in full, this decreases the risk and increases the price (and value) of the bond. If the issuing company’s credit rating declines, the increased risk can cause the price (and value) drop.
Bond Yield: How To Make Money From Bonds
There are various ways in which you can gain solid yields (return on investment) from bonds and other fixed income products:
Three Advantages of Investing in Bonds
There are three key advantages to investing in bonds and fixed income securities:
These types of financial products are generally stable, passive and predictable.
The interest rate is often fixed, which allows investors to plan cashflow, and for seniors can provide income flows throughout retirement.
Before investing in shares, bonds or other securities, make sure to seek the advice of a financial adviser, as insolvency law is complex and dependent upon different factors that can impact the outcome in a credit default or insolvency event.
The Disadvantages of Investing in Bonds
Let’s look at the downside of investing in bonds.
Long “loan terms” (maturity dates far in the future) increase the risk of rising interest rates, which in turn could impact the issuers credit risk as the interest rates on other debts increase.
Are Bonds a Good Investment?
Investing is risky, so when you are reviewing the best type of investment for you, make sure to contact a financial adviser to get advice based on your personal and financial situation.
If you’re considering buying bonds or other fixed income securities, here’s a few scenarios where bonds could be a good investment for you.
You’re looking to diversify your portfolio
If you already have a significant property or shares investment portfolio, bonds can help to diversify and spread risk. By introducing debt securities and other fixed income products into your portfolio, you can feel confident in the face of market volatility.
You don’t want too much risk
If you don’t want a high-risk investment, bonds might be a suitable investment for you.
Bond prices tend to be reasonably stable and are typically less risky than shares, and the downside is that your potential return is significantly lower with bonds than with shares.
You’re retiring or are retired
If you are retired or entering retirement, you may find a stable but conservative revenue stream is more attractive than a riskier and higher-yield investment.
Based on an average life expectancy of 81-85 years old, retiring at 60 in Australia could cost you almost $1,000,000. And that doesn’t account for inflation.
Thinking about investing?
We hope this guide has shed some light on everything you need to know about bonds and fixed income.
If you’d like to learn more, request a callback here or give us a call on 1800 319 769.
Disclaimer: This guide contains general advice only. You need to consult with your independent financial, tax and/or legal adviser, and consider your investment objectives, financial situation, and your particular needs prior to making an investment decision. Australian Bond Exchange Pty. Ltd. and its authorised representatives does not accept any liability for any errors or omissions of information supplied in this document except for liability under statute, which cannot be excluded.