The average punter is better served putting their money in the bank than in government bonds. The banks have a government guarantee anyway, so why take the inferior interest rate.
Agree with Syd, re corporate bonds. People would be eating up Sydney Airport linkers if they knew they existed!
Do you mean term deposits or some other form of bank investment? excluding shares of course as the risk factor isn't even in the same ball park.
I know there is a few term deposits out there offering 4-5+%, but usually as an introductory offer.
That would be much appreciated, DJG. I've never used bonds.
I'm sure many will have different opinions to the information I provide, but this is what I've learnt from Uni anyway.
Key Features of a Bond:
- required rate of return
- coupon rate
- face value (also known as 'par' value)
- the price (or intrinsic value)
Required Rate of Return v. Coupon Rate
- RRR is a function of 1)
prevailing level of interests rates and 2)
risk of the security - in this case, the Australian Treasury Bond.
The coupon rate:
- is the annual rate of interest paid by the bond issuer (AUS Gov't) to the bond holder (you)
- This rate is established before the debt is issued and rarely (I mean, basically never) changes throughout the life of the bond.
- You can multiply the coupon rate by the face value to determine the annual amount of interest paid.
- You can divide the coupon rate by number of payments per year to determine the size of each coupon payment. (In the case of the Aus Gov't Treasury Bonds - usually semi-annual, so 2 payments per year). - Think of it like dividends.
Face Value v. Price
- The face value is the amount that will be repaid upon maturity of the bond - the face value never changes over the life of a bond
-
the price is the present value of the future cash flows (coupon payments + face value principle), discounted at the required rate of return.
Changes in RRR & Price
inverse relationships between the RRR and the price
1) - If RRR < Coupon Rate, then Price > Face Value..therefore trading at a
premium
2) - If RRR > Coupon Rate, then Price < Face Value..therefore trading at a
discount
3) - If RRR = Coupon Rate, then Price = Face Value..therefore trading at
par
Explanation of 1): Since the RRR is < Coupon Rate, investors are willing to pay more for the bond -eg -You want 5% a year, you're offered 7% for the exact same risk..you'll always take the 7% any day of the week.
Explanation of 2): Since the RRR is > Coupon Rate, investors find the bond less attractive as they aren't getting what they require. - eg - You require 5% return, the bank offers you 4% and that's final.
Explanation of 3): - Since the RRR is = Coupon Rate, investors will be satisfied that the coupon rate is a fair return, therefore price = face value.
I won't bother talking about zero coupon bonds, ie - you only get the principle/face value at the end. - unless you want to hear about it.
Coupon Payments
As I may of mentioned above, to figure out the coupon payments, calculate as follows:
CPN = the periodic coupon payment
POP QUIZ: A 15% coupon bond has a face value of $1000. - What is the coupon payment if coupons are paid (a) annually, (b) semi-annually, (c) quarterly, (d) monthly - Be good if only the original poster or those wanting to learn bonds answers the quiz.
(a) =
(b) =
(c) =
(d) =
Valuation of a Coupon Bond
As mentioned, its based on calculating the present value of all future cash flows (
What are they again?)
CPN = the interest payments/periodic coupon payment
FV = face value of the bond
y = yield or RRR
n = remaining life of the bond
EXAMPLE: Issued on the 12 March 2008, carrying 9% p.a payable quarterly, face value of $100 and maturing in December 2010. Consisting of a yield of 8.05%p.a, what is the value of the bond?
Step 1 - Calculate Coupon Payments
Coupon Rate x Face Value/4
0.09 x $100/4 = $2.25 per quarter
There are 11 quarterly payments to be made in the remaining life of the bond
Annual yield = 8.05%, so the quarterly yield = 2.013% (rounded up) - (8.05/4 = 2.013..precisely 2.0125)
Step 2 - Using the formula and input the corresponding numbers
2.25 came from the coupons
.02013 came from the quarterly yield (can always just do 1.02013 rather than the '+' symbol)
11 came from the amount of payments remaining in the life of the bond (it's a small 11 because its '
to the power of' - it can be represented/input to a calculator by '^'
100 came from the face value.
The brackets enclosing the centre part of the formula are meant to engulf the whole middle sum (didn't know how to do it).
ie - the 1-1/(1.02013)^11 part.
Yield to Maturity of a Coupon Bond
You can calculate this if you know the price, coupon rate, face value and number of periods. I wasn't required to do this though.
Here's an online calculator for it though if you're interested:
http://www.investopedia.com/calculator/aoytm.aspx
As someone mentioned, yield to maturity is quite important.
Here is a link, the first two or three pictures summarise the interest rate/bond price correlation.
http://www.schwab.com/public/schwab...ct_of_interest_rates_on_bond_investments.html
You can change the RRR to the interest rate, as mentioned above with the 'trading at premium, discount or par' section. ie - you'd be willing to pay more for a bond that is returning 5% if the interest rates are only 4%. On the flip side, you would pay less for a bond that is offering 4% and the interest rates are 6%.
By trading in this manner, you're also capable of profiting/losing money from capital gains.
ie - the current bonds will become a lot more attractive if the RBA keeps dropping interest rates and thus the bond price will increase.
Anyway, I hope this helped a bit, by all means I'm not expert in regard to this and have never actually traded a bond in my life. I do enjoy the fundamentals behind it all though. - I'm sure a few people will provide more and accurate insight to what I've discussed.
Enjoy!