Benefits of Bond Investing
Security
In theory, in any local market, investing in government bonds may generally be
considered safe. They rank above bank deposits in terms of credit quality. While
corporate debt carries higher risk than government bonds in their respective
countries, they are considered safer than corporate equity because shareholders
rank behind bondholders if the company goes bankrupt.

Do not assume all government debt is safe. There are countries which have
defaulted on their debt obligations

Capital Preservation
With bonds, there is assurance of repayment of face value at redemption so long as
the corporate does not default. In the case of shares, there is no guarantee of the
price at which you can sell the shares, as this depends on their prevailing price in the
market at the point of sale.

Capital Gain
As bonds usually pay fixed coupons, their prices will fluctuate as interest rates in the
environment change. When prevailing interest rates rise above the bond’s coupon,
the bond becomes less valuable and its market price could fall below its face value.
Conversely, when prevailing interest rates are lower than the bond’s coupon, the
bond becomes more valuable and its market price is likely to rise above its face
value.

Generating Passive Income

Bonds usually pay coupons which provide income over the period you hold the
bonds. Dividends from equity in comparison are neither certain in quantum nor are
they obliged to be paid out.

Example
You plan to increase your retirement income by an additional $250/month. You
currently have $100,000 in your savings, instead of drawing down on your capital,
you could consider buying a retail bond with a 10-year term-to-maturity that pays out
a coupon of 3% with those savings. The bond will pay out $3,000 a year while
preserving your capital of $100,000.

Diversification
In some economic conditions, bond prices move inversely to stocks. While this
negative correlation to stocks does not always hold true, bonds can help to reduce
the overall volatility of an investment portfolio.

© The MoneySENSE-Singapore Polytechnic Institute For Financial Literacy

  
 
Risks of Bond Investing
Bonds are exposed to:

 Interest Rate Risk and Capital Loss

A basic relationship that bond investors must keep in mind is that interest
rates and bond prices move in opposite directions. When interest rates rise,
bond prices fall and when interest rates drop, bond prices move up. Hence
capital loss may be incurred if bonds are sold before maturity.

 Default (Credit) Risk

The risk that the issuer fails to make timely principal and coupon payments as
contracted.

 Reinvestment Risk
The risk that the coupon payment on a bond may be reinvested at a lower
interest rate as compared to the market return of the bond at the time that the
coupon payments are paid to the investor.

 Currency Risk
The risk that returns may be affected by the prevailing foreign exchange rate
when the coupon and principal payments are paid out.

 Issue Specific Risk

Features built into a bond which under certain circumstances stops paying
interest to the holder or may cause a bond to be redeemed early. For
example, when forcible equity conversions or options are exercised.

 Inflation Risk
If the inflation rate rises above the interest rate of the bond, the real return of
the bond is negative.

 Liquidity Risk
The risk that a bond will be difficult to sell at a reasonable price at the time
that the investor wants to sell it.

© The MoneySENSE-Singapore Polytechnic Institute For Financial Literacy