Bonds are one of the most conservative investment instruments. Their profitability is low, but guaranteed. Very often, novice investors, either cautious and resource-constrained stock market players, include bonds in their portfolio or are limited to them at all. A recent bond analysis shows that an increasing number of people are interested in the financial capabilities of this tool. It’s excellent to navigate the bond market and get the maximum guaranteed income from their ownership. The main thing is to have a reliable strategy and have all the information in it.
How the bond market works
A bond is a debt paper. The principle of operation of this paper for us, as for investors, is extremely simple. The state or enterprise, depending on the type of bond, issues a certain number of debt securities in order to raise funds. For an issuer, that is, an organization issuing bonds, it is more profitable than a bank loan. Bonds enter the stock market and are sold to investors. Each market participant has the right to buy the required number of bonds at their face value. When buying, we know exactly when and with what percentage the bond will be repaid.
A bond holder is entitled to resell the security to other market participants at its discretion. He also receives the so-called coupon income for the entire duration of the bond. The coupon is akin to interest on the deposit, so bonds are often compared with deposits. However, the return on ownership of a bond can be significantly higher than on a deposit.
Bond yields
The most interesting thing on the securities market is that by applying the right investment strategy, any instrument can be turned into a highly profitable one. Bonds are not an exception in this regard, the analysis and strategies of which reveal a ton of options for long-term capital appreciation. If we talk about the percentage, the yield on bonds ranges from 6 to 18% per annum, depending on the type of paper. Corporate bonds show the highest returns, and government bonds show the lowest.
What is the bond yield made up of?
- The difference between the purchase price and the par value at which the repayment is made. A bond is traded on the securities market for its entire life. It is not uncommon for paper to be bought at a price below par. Then the investor gets this difference into his account.
- Coupon income. The size of the coupon to the investor is known in advance and remains unchanged throughout the life of the paper. The lowest coupon on federal loan bonds. Corporate bonds set the coupon at their discretion. Sometimes, in order to attract a large number of investors, private companies claim a rather high percentage of coupon income. It should be understood that in this case, the risk of falling nominal values also increases.
So, the analysis of bonds demonstrates a direct dependence of the yield of a particular paper on its type. It's time to figure out what the classification of bonds is.
Government bonds
The most common classification is by type of issuer, that is, the organization issuing the paper. The largest and most reliable bond issuer is the Ministry of Finance. Such securities are called federal loan bonds (OFZ). They have the highest reliability, are practically not subject to fluctuations in market prices. But the coupon income on these securities is almost equal to the interest on deposits of large central banks.
There are also municipal bonds. These are papers issued by constituent entities of the Russian Federation. For example, you can purchase bonds of the region or region in which you reside. Here, the market price may give slight fluctuations, depending on the term of the bond and the position of the economy in a particular region. The coupon income of the subject is also entitled to establish at its discretion. It can be both higher than OFZ and equal to it.
Private Campaign Bonds
The most interesting in terms of investment are corporate bonds. Their coupon income can be several times greater than the yield on coupons from OFZ. But with increasing benefits, so does the risk.
Corporate bonds are issued by legal entities: large corporations, banks, etc. Organizations guarantee the return of funds borrowed from securities with their property. The larger and more stable the campaign, the more reliable its bonds. However, the analysis of bond yields often revealed cases when investors were able to earn on bonds of small campaigns developing in promising areas. In order to successfully implement such a risky investment strategy and invest in the securities of little-known campaigns, you need to have excellent financial instinct and remarkable analysis capabilities.
Maturity
There is another criterion by which classification and analysis of bonds is often carried out - their maturity. According to this principle, securities are divided into:
- short term;
- medium term;
- long term.
The first and second are most common among issuers and among investors. In terms of this classification, the Russian securities market is significantly different from the western one. Our short-term securities have a maturity of 3-6 months to a year. Medium-term - 1-5 years, long-term - more than 5 years. In the West, these dates are much more impressive. This is due to the greater stability of the western economy. In Russia, not a single investor will dare to buy a bond of any campaign with a maturity of 30 years. Even 5 years is too long for our ever-changing economic realities.
Investing strategies
How can one earn good interest without taking action on the stock market? The bond market, the analysis and strategies of which are very diverse, provides several options to choose from.
The “Ladder” strategy involves the purchase of the least risky securities in stages: a package of bonds is purchased with a maturity of 1 year. After a year, the investor receives coupon income and returns the invested funds. For the entire amount of proceeds, bonds are purchased with different maturities from 1 to 5 years. Thus, money, constantly working, brings a good total income. At the same time, the investor practically does not risk his own funds, he does not need to constantly monitor the stock market or the jumps in prices for certain securities.
The “Bullet” strategy, on the contrary, requires constant work with the market and involves the purchase of bonds at different times on the most favorable conditions. That is, the investor must track when the market price of the paper is as low as possible. Thus, a portfolio is formed of bonds with the same maturity, but purchased at the most favorable market price at different times. Here the benefit is formed not so much due to the coupon income, but due to the difference in the purchase price and the redemption price.
What is more profitable?
Many beginning investors often have the same question. They ask, having familiarized themselves with all the possibilities of the stock market and having analyzed it: stocks and bonds - what is more profitable?
There can be no single answer to this question. It all depends on the investor himself, his ability to navigate the securities market and the financial market as a whole, his willingness to take risks for the sake of greater profit, the amount of free time that he is ready to devote to trading. The higher the financial literacy and the more opportunities to monitor the market - the more opportunities to quickly and earn a lot from constant speculation in stocks. Bonds are designed for a longer term. Therefore, they are preferred by more conservative investors. However, the analysis of bonds, like any other securities, does not tire of confirming the main truth of investment: you should work with all available instruments, the main thing is the right strategy.
What to read
A lot of books have been written about the bond market and their opportunities. One of the most popular is Frank Fabozzi's “Bond Market Analysis and Strategies”. This book has long been highly respected among financiers. It even builds lectures on financial literacy of many leading business schools. It will be good for those who are not a professional financier, but want to learn how to make money on the bond market on their own. The contents of Fabozzi's book “Bond Market Analysis and Strategies” will help to understand in detail the types of these securities and choose the most suitable strategy for working with them.
Bond Market Forecasts
The forecast for the bond market is always directly dependent on the discount rate of the Central Bank. As soon as the Central Bank rate begins to move upwards, the yield on bonds increases. With the beginning of the reduction of the key rate, the yield on bonds immediately decreases. Due to the fact that the Ministry of Finance continues the tendency to reduce the key rate, in the near future the bond market expects the same consistent decrease in yield.
Despite this forecast, bonds are still a popular and attractive investment tool. They consistently make worthy and profitable competition to a bank deposit.