Bonds Flashcards
What is a bond
An IOU indicating that an organisation has borrowed money from an investor
Key Features of a Bond
Issuer – entity borrowing money
Bondholder – investor lending the money (purchasing the bond)
Face Value – loan size, amount repaid at maturity
Coupon – interest that the issuer will pay to the bondholder (annual rate)
Maturity Date – date on which the borrowed money will be repaid
Corp Bond Features
Shareholders are part owners of the company
Bondholders are creditors of the company
Do not typically have voting rights
Do not typically participate in future profits
Are usually entitled to their interest payments before ordinary shareholders get their dividends
Do typically have a claim upon the assets of the company ahead of shareholders
Bond Yield
Coupon
Interest paid on the bond (% of FACE value)
Income Yield or Running Yield
Interest paid on the bond as percentage of CURRENT price
Yield to Maturity (YTM) or Gross Redemption Yield (GRY)
Total annual return on the bond if held to maturity
Bond Price
Prices quoted in relation to 100 (percentage of face value)
As bond approaches maturity, price approaches 100 (Par)
Bonds can price at a discount or premium to face value before maturity
Capital gain / loss
Changes in price affect a bond’s yield
What is bond duration
A measure of the sensitivity of a bond’s price to a change in its yield (i.e. a measure of interest rate risk)
The higher the duration, the more sensitive the bond price = higher volatility
Clean v Dirty Price
Clean price
Most often quoted
Excludes accrued interest on the bond
Dirty price
Includes accrued interest on the bond
Effective price paid by the purchaser of the bond
Taxation
Coupon interest paid gross
Taxable unless the bond is within an ISA or SIPP
Seller of bond pays tax on interest accrued up to transfer
Buyer gets tax relief on interest accrued on bond purchased
Typically no CGT on disposal for ‘qualifying’ bonds
Most UK bonds are qualifying (sterling denominated, non-convertible, issued at or around ‘par’)
Factors that influence a bond price
Macro economy (changes in interest rate/inflation expectations, economic growth projections, politics etc.)
Change in a company’s financial position (profitability, leverage, gearing)
Shifts in risk appetite (corporate spreads vs rates)
Mergers & Acquisitions
Liquidity (bid/offer spread)
Why invest in bonds
Because they provide reliable income and tend to be less volatile than equities but returns are typically lower
Reliable Income
Visibility over amount and timing of interest payments
Visibility over amount and timing of principal repayment
Not reliant on a market price if held to maturity
Diversification
Typically lower risk than equities of same company
Combining a number of different individual bonds can help to reduce default risk impact on a portfolio
Lower volatility than equities
Attractive returns!
Can be tax efficient.
Head of bond research
Mat Malek
How does inflation impact bonds?
Because it erodes value of future fixed coupon payments and principal repayment at maturity and may lead to interest rate rises.
What are the Gilt Yields
2yr
5yr
10yr
Yield to Maturity
2yr = 4.19%
5 yr = 4.27%
10 yr = 4.52%
Benefits of Offshore Bonds
Shielded from ongoing UK taxes whilst within offshore bond
Client may withdraw 5% of the original capital
Withdrawals in excess of this amount are subject to income tax on the gain
Top slicing relief is available to reduce the tax payable by spreading the gain over the number of years the bond has been held
Utmost, CLI and Standard Life
