25 Nov 2022
Some people find bonds ‘boring’ because you don’t often hear much about them in the news. Their volatility is generally lower than that of equities, as is their long-term return potential. However, bonds can provide a steady stream of regular income and balance the overall risks of a portfolio, especially amid market downturn when stocks are generally more vulnerable.
Simply put, a bond is a type of agreement issued by governments or companies to raise funds (borrow) from investors. The issuer promises to repay the interest and principal amount by a set date known as maturity. Traditional bonds have fixed and recurring interest payments (coupons), which is why we also refer to bonds as fixed-income investments. But variable or floating coupons based on an underlying interest rate are also common.
Bond prices are inversely correlated with interest rates. When rates go up, bond prices fall and vice versa. For a $100 bond with a fixed coupon rate of 5% and a maturity of 5 years, investors will receive an interest income of $5 annually for four years, and $5 plus the $100 principal in the fifth year.
Bonds carry credit risk and the ability of the issuers to make payments is measured by industry credit ratings. A bond's credit rating indicates its credit quality and is based on the issuer's financial ability to make regular interest payments and repay the loan in full at maturity. Credit rating agencies (e.g., Moody’s & Standard & Poor’s) help to evaluate the creditworthiness of bonds.
When the economic outlook is deteriorating, investment grade bonds are usually preferred due to their higher quality to build portfolio resilience. Conversely, high yield bonds will be in favour when markets are buoyant.
Bonds are often a good portfolio diversifier to help investors ride through market volatility. Contact us to find out what types of bonds are suitable for you.
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