What Is a Bond?
A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer. Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.
KEY TAKEAWAYS
- Bonds are units of corporate debt issued by companies and securitized as tradeable assets.
- A bond is referred to as a fixed income instrument since bonds traditionally paid a fixed interest rate (coupon) to debtholders. Variable or floating interest rates are also now quite common.
- Bond prices are inversely correlated with interest rates: when rates go up, bond prices fall and vice-versa.
- Bonds have maturity dates at which point the principal amount must be paid back in full or risk default.
The Issuers of Bonds
Governments (at all levels) and corporations commonly use bonds in order to borrow money. Governments need to fund roads, schools, dams or other infrastructure. The sudden expense of war may also demand the need to raise funds.
Similarly, corporations will often borrow to grow their business, to buy property and equipment, to undertake profitable projects, for research and development or to hire employees. The problem that large organizations run into is that they typically need far more money than the average bank can provide. Bonds provide a solution by allowing many individual investors to assume the role of the lender. Indeed, public debt markets let thousands of investors each lend a portion of the capital needed. Moreover, markets allow lenders to sell their bonds to other investors or to buy bonds from other individuals—long after the original issuing organization raised capital.
What are different types of bonds available in the Philippine market?
There are two general types of bonds that you can acquire: government bonds and corporate bonds.
Government or treasury securities
Government bonds are issued by the Philippine government through the Bureau of the Treasury, and that explains that they are also known as treasury bonds. They are offered in two different ways: through auction and directly to the investing public. In auctions, the bonds are held up for bidding commonly to institutional investors who would then have the option to make it available to the general public.
On the other hand, the Bureau of the Treasury also sell directly to the public without going through the bidding process. One example of this is a Premyo Bonds which offered by the BSP last year of 2020.
Government or treasury bonds are considered to have the least risks, and that is because they are backed by taxpayers. The risk of default is relatively low. However, it is also important to bear in mind that some countries in the world were historically unable to settle their debt obligations in the past. Argentina for example defaulted on its foreign debts in 2001
- Treasury bills are shorter in term, usually less than a year. Interest is not paid, instead the bills are priced at a discount. Your income is derived from the difference between the discounted price you paid and the full amount that the government pays back, which is called “spread”.
- Fixed Rate Treasury Notes (FXTN) pays semi-annual interest or as described during the offer.
- Retail treasury bonds (RTB) are longer than FXTNs. They usually carry quarterly interest payments.
- Republic of the Philippines (ROP) bonds are dollar-denominated debt instruments.
Corporate retail bonds
Corporate bonds are issued by private corporations that are publicly listed on the stock exchange. Announcements are made in major broadsheets and newspapers in the country, inviting investors who may want to get them.
Advantages of bonds
What are the benefits when investing in bonds? There are many advantages that these types of investments have over other income-generating options.
- Fixed income. The issuer is going to pay predictable interest periodically. The interest can be paid quarterly, semi-annually or any other frequency.
- Less volatile. There is less volatility with bonds compared to holding stocks, and that is because the income from them (which is the interest) are already known and fixed from the beginning. The same cannot be said with stocks. The value of stocks change and it is difficult to predict its future stock price over time.
- Comparatively less risky. If a company goes bankrupt, whatever assets it has left will be liquidated to pay its debts. Since bonds are essentially debts, bond-holders are given priority to be paid first than those who hold stocks. Government bonds are generally perceived to have the least risks because they are guaranteed by
- Liquid. If you want to get your capital back before the term ends, you can do so by selling your holdings on the secondary market. Similarly, if you want to acquire bonds
- Diversify risk portfolio. Bonds are a way to disperse risks in a given investment portfolio. It gives you exposure to less volatile assets that provide periodic income.
- Interest is better than banks. Most of the time, the income that you can potentially derive from bonds through interest payment is higher than the ones provided by bank accounts such as savings account or time deposit.
What are the risks in bond investing?
But what are the disadvantages? Remember that all forms of investing have risks, and that is true with bonds as well.
- Taxable. Whatever you earn from them is subject to tax of 20%. You don’t get the entire interest as your income earned, unlike in long term negotiable certificate of deposit (LTNCD) when held to maturity.
- Risk of default, also called credit risk, is a situation where the company cannot pay the interest on the due date or the principal amount on maturity. That’s why credit ratings companies exist such as Standard & Poors and Philippine Rating Services Corp. (PhilRating) that assess the credit-worthiness of the companies and their issued bonds.
- Interest rate risks. When interest rate (which is set by the Bangko Sentral ng Pilipinas) increases, the yield that you get from bonds decrease. That is because the new and higher interest rate becomes more attractive than the interest given by long-term bonds.
- Liquidity risks. There might also be a concern on how quickly you can trade (buy or sell) the bonds to the second market particularly when yields are not attractive due to high interest rate.
- Inflation risk. When inflation spikes, the purchasing power of the fixed income that you get is lessened.
- Reinvestment risks. When the central bank lowers the interest rate, your earnings when you reinvest the fixed income derived from bonds may also be less. Also, there are callable bonds where companies can decide to pay back investors to take advantage of low-interest years. They choose to settle the long-term, high-interest bonds in order to borrow money at less interest.
- Opportunity risk. Studies show that stocks outperforms bonds in the long term, and yet during market volatility and recessions bond yields can be attractive.
Is investing in bonds right for you?
Bonds can be an option for anyone who do not want to be exposed to the volatility of stocks, and instead they prefer to received predetermined and predictable income from interest. Experts also recommend them when investors would like to have lesser chance of capital loss than stocks. So they can be suitable for investors who are conservative and do not like substantial risks in their investments as well as for those may need to receive periodic earnings, such as retirees.
How can you invest in Philippine bonds?
There are many ways to acquire bonds depending on the timing: within offer period, through Bureau of the Treasury and authorized partners; outside of offer period, you can invest through the through the secondary market and through bond funds.
Regardless on how you acquire them, there are basic requirements that you need to prepare.
- Valid identification cards
- Tax identification number or TIN
- Minimum capital starts at ₱10,000 or ₱50,000.
- Bank account where your interest and, upon maturity, your capital are going to be deposited
Through Bureau of the Treasury and authorized partners
If the treasury and corporate bonds are within offer period, you can acquire them through the Bureau of the Treasury or authorized partners, which are usually banks and investment houses.
How do you know that they are up for grabs? They are usually announced within the business sections of newspapers and broadsheets. You can just go to the Bureau of the Treasury website for further instructions. Check out this article as well on retail treasury bonds.
Through the secondary market
But what if you are late into the game and you want to buy them after the offer period? Don’t worry. You can do so through the secondary market, which is the Philippine Dealings and Exchange Corporation (PDEX). You would need to open an account with brokers, and fees are going to be charged when you trade through them.
- Allied Banking Corporation
- Asia United Bank
- Asiatrust Development Bank
- Banco de Oro Unibank, Inc.
- Bank of Commerce
- Bank of the Philippine Islands
- BDO Private Bank
- China Banking Corporation
- Chinatrust (Phils) Commercial Banking Corp.
- Citibank, N.A.
- Citibank Savings, Inc.
- Citystate Savings Bank
- Deutsche Bank
- Development Bank of the Philippines
- East West Banking Corporation
- Export and Industry Bank
- Hongkong and Shanghai Banking Corp.,Ltd.
- ING Bank
- JP Morgan Chase Bank, National Association
- Land Bank of the Philippines
- Maybank Philippines, Inc.
- Metropolitan Bank and Trust Company
- AIG Philam Savings Bank
- Philippine Bank of Communications
- Philippine Business Bank
- Philippine National Bank
- Philippine Veterans Bank
- Planters Development Bank
- Rizal Commercial Banking Corp.
- Robinsons Savings Bank
- The Royal Bank of Scotland (Philippines), Inc.
- Security Bank Corp.
- Standard Chartered Bank
- Union Bank of the Philippines
- United Coconut Planters Bank
- AB Capital and Investment Corp
- BPI Capital Corporation
- First Metro Investment Corporation
- Multinational Investment Bank Corporation
- BDO Capital and Investment Corporation
Buying bond funds
Lastly, you may also indirectly own them bond funds. Bond funds are investment funds that are managed on your behalf, so you don’t have to spend the time or learn the skills in trading them. You can actually open any of the following accounts: mutual funds, unit investment trust funds (UITF), Personal Equity and Retirement Account (PERA), or variable universal life (VUL) policy.
Sources: Investopedia and Pesobility