Risk of investing in Bonds
* Credit Risk * Interest rate risk * Liquidity risk * FX risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised
Moody investment grade rating
Aaa , Aa1 , Aa2 , Aa3 , A1 , A2 , A3 , Baa1 , Baa2 , Baa3
Moddy Non-investment grade
Ba1 Ba2 Na3 B1 B2 B3 Caa1 Caa2 Caa3 D
S&P and Fitch investment grade rating
AAA AA+ AA AA- A+ A- BBB+ BBB BBB-
S&P and Fitch Non investment grading Rating
BB+ BB BB- B+ B B- CCC+ CCC CCC- D
Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realize greater yields by switching to other investments that reflect the higher interest rate. For example, a 5% bond is worth more if interest rates decrease since the bondholder receives a fixed rate of return relative to the market, which is offering a lower rate of return as a result of the decrease in rates
Liquidity Risk
In an Liquid market, investors run the risk of either having to retain the bond till maturity or selling it before maturity at an unfavorable price
Issue size = liquidity ? (>US$500m more liquid ?)
Establishing a fair price & price comaprisons can be difficult or impossible as there are sometimes no Counterparties interested in the bond.
FX risk
Morgan Stanley 7.625% Aust dollar bond Due 2016
Aud/SGD 1.33 (1
st Feb12)
Aud SGD 1.254(1
st Jun12)
Aud/SGD 1.285(12
th Dec12)
If U borrow (due to low rate 1.55%) SGD or USD to convert to Aust to buy Aust bond. There is a FX risk which may go against you
Bond Types
Fixed Rate bond (straight bond)
Fixed maturity & fixed cash flow pattern (I.ecoupon)
Eg NOL 4.25% due 2017
Olam 4.07% due Feb 2013
Callable bond
Gives the issues the right to buy back all or some of the issues prior to maturity
Call price : Specified price at which the bond may be repaid
Eg Hyflux 4.25% 2018. (Callable on 7 Sep15 @ 102.13)
Perpertual bond (some do come with callable term)
Bo
nd in which the
issuer does not repay the
principal. Rather, a perpetual bond pays the
bondholder a
fixed coupon as long as he/she holds it.
Prices for perpetual bonds vary widely according to
long-term interest rates. When interest rates rise, perpetual bonds fall and vice versa.
Inflating-linked bond
Pays a fixed coupon + an amt that is linked to a price index to compensate for inflation
* S’pore’s central bank is studying the feasibility of selling
Inflation-linked bonds to help citizens boost on savings amid low interest rate ( Bloomberg 9th Jul 2012)
Convertible bond
* Hybrid that combines both equity & debt features
* Holders have the right to convert the bond into issers’s equity in a predominated ratio during a specified conversion period
Eg Keppel land 1.875% due 2015 convertible bond
Conversion price @ $6.72. ( Now trading @3.8)
Bond structure
Unsecured Bond that is not secured by a collateral.Most bond are unsecured
Secured Bond.
Bond is backed by a Collateral
Eg OUE 3.36% due 2013.
Back by Mandarin gallery & Mandarine Orchard.
Bond seniority
bondholders are credits & therefore have a higher priority calim than equity holders in a liqudation or restructuring scenario.
Senior bond has a higher priority claim than other bonds on the assets issued by the same entity.
Subordinated (junior) bond A class of bond that, in the event of
liquidation, is prioritized lower than other classes of bonds. For example, a subordinate bond may be an
unsecured bond, which has no
collateral. Should the
issuer be liquidated, all
secured bonds and similar
debts must be
repaid before the subordinated bond is repaid. A subordinate bond carries higher
risk, but also pays higher
returns than other classes
I am new in bond investing (started in 2010). I am no expert. Pls get your knowledgable relationship manager to explain to U on fixed income investment.