Bond Basics
17 September 2007After last Friday's EB, I was originally thinking of writing about UITFs but thought it might be better to discuss the assets held by these funds. Because FM is a bulletin board primarily dedicated to the discussion of the Philippine Stock Market, I presume everyone is familiar with stocks, the holdings of equity funds. The focus of this article will then be bonds which comprise the portfolio of bond, fixed income, and (partly of) balanced funds.
Simply put, bonds represent debt obligations that promise to pay a specified sum of money on a specified future date(s). The issuer of a bond is called a borrower. The investor in a bond is called a creditor. The term to maturity of the bond is the number of years between its issue date and its maturity date. The issuer pays interest on the amount borrowed until the bond's maturity date when the principal is returned and the debt extinguished.
The bond has a par value (sometimes called face value or principal) which is the amount the issuer agrees to pay the bondholder on maturity date. Bond prices are usually quoted as a percentage of a bond's par value. A bond that is trading at 100% of its par value is quoted as trading at 100. Bond prices may trade at a discount or below a bond's par value or at a premium or above a bond's par value. The price of a bond will determine the market value of a bond.
A bond may pay interest monthly, quarterly, semi-annually or annually. These interest payments are called coupons which are determined by a coupon rate multiplied by the par value of the bond. For example, a bond with a par value of PhP 1,000 and that has a coupon rate of 10% annually will pay an investor PhP 100.00 once a year. If the bond pays a semi-annual coupon, an investor will expect to be paid PhP 50.00 every 6 months. If the bond pays a quarterly coupon, an investor will expect PhP 25.00 every 3 months. Bonds that do not pay any interest over the life of the bond but instead pay the interest on maturity date are called zero coupon bonds.
Examples of bonds in the market are government securities denominated in Philippine Peso like the fixed-rate treasury notes (FXTN) auctioned by the government on a regular basis and the retail treasury bond (RTB) offered to retail investors. The difference between the 2 issues is that the RTB can be purchased in denominations of PhP 5,000.00 while the FXTN requires larger denominations. The coupon of the RTB is paid out quarterly while the coupon of the FXTN is paid out semi-annually. The recent RTB issue was last August 1, 2007 with a 3-year tenor with a coupon of 6.875% p.a. and a 5-year tenor with a coupon of 7.125% p.a.. The last FXTN issued was on September 6, 2007 and it was a 20-year note that paid a coupon of 8.625% p.a.. Mind you, the coupons are paid less 20% withholding tax.
The government has also issued US Dollar Denominated Bonds which were mainly sold to foreign investors. These bonds are traded both here and in international markets. The last issue of the Republic of the Philippines was on January 15, 2007 maturing 25 years on January 15, 2032 with a coupon 6.375% p.a..
Corporate bonds issued by Philippine companies are not as frequent as government issues as many companies still prefer to raise capital via bank loans or stock offerings. However, the past few years have seen the increased issuance of bonds, preferred shares (a type of fixed income security), and hybrid structures. Ayala Corporation issued a 5-year bond last October 2004 with a coupon of 12.677% and First Gen Corporation issued a 5-year bond last February 2005 with a coupon of 11.55%.
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do bonds offer better returns than special time deposit accounts that offer around 5% net?
In general, bonds offer better yields than the time deposits of the most creditworthy banks. The main hurdle is the size of the investment. Unless it is a retail treasury bond primary offering, financial institutions will usually require a minimum amount in the hundred(s) of thousands to millions to place an order to buy a bond.
1.if bonds can rise and fall like stocks, how do they differ with stocks in terms of risk and whatever? as seen with CMP bonds that became junk bonds
2.why do different banks have different bond prices. Won’t there be a “centralized” bond exchange like the pse?
as far as i know, bonds offer less risk than stocks, as a creditor, you will be the first priority to be paid in case the firm liquidates, they also give fixed income return as they say it although not so true. Common stockholders will get what is left after liquidation, meaning after bondholders are paid, and preferred stockholders are paid. As for Junk Bonds, it’s not necesarily that they are junks, it just means that the bond has a high risk of defaulting, it also usually offers a high rate of return, this type of bonds may be compared to speculative stocks.
basura stocks and basura bonds
master rex, you are correct that the fixed return and the seniority of debt over equity reduce the risk exposure of creditors versus shareholders.
master dragon, bonds may be listed on an exchange but they may also be traded over-the-counter with banks quoting their bid and offer for different bonds.
btw i will be coming out with part 2 of this series on bond pricing.
master prom, im just a follower of yours. Bow