# Bonds vs. Fixed Interest



## osmosis (20 September 2007)

A very basic newbie question.

What is the difference between putting a lump sum of money into a bond vs into a high interest bearing bank account? Which is better for long term growth?
I assume a bank account is more accessible.

How does one go about investing one's money in bonds and can one withdraw at any time? Are there any downsides to bonds. How are they taxed?

Many thanks for the help.


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## osmosis (17 October 2007)

*Re: Bonds vs Fixed Interest*

Hi again.

Just bumping up this post. Any help on bonds versus a high interest bank account would be appreciated. Thanks.


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## Flying Fish (17 October 2007)

*Re: Bonds vs Fixed Interest*

Yes indeed


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## cuttlefish (17 October 2007)

*Re: Bonds vs Fixed Interest*

I'm not any kind of expert in this sort of stuff but since you've got no replies can have a bit of a go at answering some of it, I'm sure someone will jump in and correct any mistakes.


* bonds - depends on the issuer as to their quality. Bonds are generally redeemable for face value at maturity though there's different types, some that build in the return of principal into the coupon/interest rate. The return is fixed.  They are generally tradeable. The value of the bond declines if interest rates go up, the value of the bond increases if interest rates go down (though its not as simple as this because it depends on the relative value and time to maturity on the bond).

* fixed interest bearing account ("Fixed term deposit") - not tradeable. Typically can get your money back early by paying some kind of break penalty otherwise have to have the money sit there till maturity. If interest rates rise significantly during the term then you lose out, if they fall you win out.  Because banks put margin on it its likely you'll get a better return from direct investment in bonds.

* variable rate interest bearing account. Not tradeable but doesn't really matter because the money can be withdrawn at any time. As I understand it the interest rate is determined by the movement of the overnight cash rate which is the rate banks lend to each other on a very short term basis. The banks will have their own margin on this of course.

In the current "sub-prime" meltdown climate its well worth doing some investigation into the quality of these assets as well.  Are the bonds backed by government, or by mortgages, or by corporate etc..  Is the bank thats providing the high interest funding that high interest via mortgages, bonds or via overnight cash products etc.  (i.e. make sure its a genuine cash mgt account, or govt bond etc.).   Also the capital adequacy requirements for banks for variable rate accounts vs fixed rate accounts varies as well - I think they need to maintain higher levels of capital for variable rate accounts, and there's also a difference possibly between bank and non-bank accounts and also overseas banks vs australian banks that may have different regulations and sources of capital/funds as well.


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## osmosis (17 October 2007)

*Re: Bonds vs Fixed Interest*

Many thanks for the informative reply.

I know that the RBA trades government bonds to individuals. 

I think my main question is why should I hold a bond for a relatively long term (eg 5, 10 or 30 years) and run the risk of not getting face value for it if redeemed prematurely, when I can put my cash in an internet based account where it is readily accessible and where the interest rate is higher than a government bond? 

Thanks again.


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## CFD (17 October 2007)

*Re: Bonds vs Fixed Interest*

The interest rate is relative to risk, only you can answer as to how much extra risk you wish to take in return for a higher rate. Obviously our Govt. Bonds are about as safe as we can get. 

As advised by cuttlefish, bonds are only redeemable from the issuer on maturity. You can sell them on the market but the price available will fluctuate with the prevailing interest rate. That is your coupon rate will be worth more to a buyer if the rates have fallen since you bond was issued, and worth less if it has risen. 

If these types of securities are of interest to you, you may wish to look at hybrid securities. These relate to off balance sheet fund raising by banks and others and work similar to Govt. bonds be it with a higher interest rate and risk.

If you prefer internet based accounts this site gives a good comparison of what's available. 
http://www.raboplus.com.au/savings/compare/default.aspx


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## cuttlefish (17 October 2007)

*Re: Bonds vs Fixed Interest*

osmosis - even with an internet based bank account its worth doing some checking to understand the nature of the institution providing that account and potential exposure and security of the cash in there.  Have a good read of the terms and conditions of the accounts and see if you can find out where they are investing the money (i.e. how are they generating the interest income).


Basically any money that isn't cash in your hands is on loan to someone.  A deposit in a bank account is really a loan to that bank. Thats why banks internally refer to deposit accounts as liabilities and loans as assets.


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## xtanda (18 October 2007)

*Re: Bonds vs Fixed Interest*

IMHO, as long as you stick to the big bank / big brand that has reputation to maintain or too big to be go under (in which government will help), the fixed interest online saving is as good as bond (in term of security) with higher rate.

On the other hand, putting investor hat, nothing beat investing. Just doing very conservative strategy such as monthly covered call, you will easily grab around ~1.5% a month (after brokerage) which translate to ~18%p.a... with relatively low risk.....
If you want iron clad protection/100% protected one, buy put option on your covered call... you'll find that it still at least about double the bank's offer. Not to mention if the company give dividend.....

Just give you idea, not advice....


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