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UDAYSINH JAGTAP What Is A Bo nd? termed as bond. Investors have an opportunity to invest in such projects. Bonds can be referred to as gilts, bills, notes, debt securities or debt obligations. The issuer, government or corporation

rate of interest per annum. Thus, the return an investor can expect to get from a bond comprises of two elements: income (coupon) and price movements (capital gain); the summation of two is known as the yield. Understandably, if a bond is issued at face value and held to redemption, then assuming it is redeemed at par, the return will simply comprise of the income investments. It is important to note that a bond is completely different from a bond fund, which is a fund that primarily invests in various bonds. Nevertheless, bonds too are traded on secondary markets.

Fac to rs Affe c ting Inve s tme nt In Bo nds of interest, yield, maturity, redemption features, default history, credit ratings and tax status (though not relevant for Singapore residents). Major credit agencies across the world (Moody s and Standard & Poor) typically rate bonds into two broad categories, namely: the investment grade (Baa/BBB to Aaa/AAA), which is considered the strongest, and the non-investment grade (Ba/BB to C/D), which is already in default. These agencies not only rate bonds, but companies and countries too! While the non-investment grade bonds are also considered to be speculative or junk bonds, those in default entail failure of the issuer to make timely coupon or principal (re)payment.

Unde rstanding Ho w Bo nds Wo rk rates. In such scenarios, the investor may get a better return on term deposits in bank. Coupon payments, on the other Indeed, it would be a loss-making proposition if the investor intends to sell the bond at this point in time. On the other hand,

Let s review this in detail. Following a rise in interest rates, the new bond offering from the issuer and the bank deposits too, follow suit. This entails that the existing bond with a lower coupon loses its shine. Of course, some of the existing bond investors liquidate their money and opt for new avenues offering better returns. This in turn exerts pressure in 4


the secondary market, ultimately leading to a drop in bond prices. Likewise, the bond price will increase if the interest rates are reduced.

Is A Bo nd Re ally A Lo w Risk Inve s tme nt? Known as an honest broker between political parties in the US, Congressman Jim Cooper once famously said if you need to put your money in a safe and secure place and you want it to earn interest, treasury bonds are safer than putting it in any bank as a deposit or putting it anywhere else, because they are backed by the full faith and credit under the bridge since then, and now we have a reverse stand on the US economy. Bond King Bill Gross, founder of PIMCO the world s largest bond holder, has enunciated

1%-2% not 3%+ as we used to have . Europe has a different problem altogether. Recently, we all have witnessed much media coverage about the Euro-crisis thanks to the PIIGS (Portugal, Italy, Ireland, Greece and Spain)!!! Trading on 8 July 2011 at London showed that the ten-year yield on government bonds for these countries range between 5.27% (Italy) and 17.50% (Portugal).

in developed countries. Whilst Japan has the highest public debt which is twice its GDP, the US is racing to attain a debt that would be equal to its GDP. American President Barack Obama has a deadline of 2 August, 2011 to raise the existing USD14.3 trillion borrowing cap by an amount that would facilitate the US to meet its obligations. By the time you read this article, American Congress might have raised the current debt limit. However, the damage has already been done. In early June this year, credit rating agencies in Germany and China downgraded the US. While Feri (Germany) blamed high prospects for this demotion, Dagong (China) has claimed that the United States has already been defaulting . With interest rates at an all-time low across major economies, they can only rise from the existing levels the question is what effect will this have on bond prices? Absolutely they are slated to slump!

Call Fo r Ac tio n You might have realised by now that direct investment into bonds may not be the best option for individual investors. For those of you who still wish to invest in bonds, you will need to have a better understanding of their credit rating, maturity term and potential returns.

years work in India, UK and Singapore; for your comments and queries send email to: uj@thehenleygroup.com.sg

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