Bond Investing Guide 1: What are Bonds?

You have already learned the basics of stock trading and investing in our Stocks Tutorial and Guide. This time, lets learn another financial instrument: Bonds. What are BONDS? In very simple terms, a bond is an obligation by the borrower (bond issuer) to pay the lender (bondholder) a specific amount of money at specified times in the future. Like stocks, bonds are issued as a way of raising funds. If a company, for example, needs money to expand the business or to pay out loans, they can choose to use stocks or bonds to raise capital. Stocks vs. Bonds? A major difference between a stock and a bond is that stocks do not guarantee any future payment (dividend) while bonds have a known and specific payment in the future (coupon interest). This means if you invest in stocks, you are not sure if you can earn by receiving dividends. Companies, even if they are profitable, are not obligated to pay dividends to their shareholders.

Bond issuers, on the other hand, are required to announce a specified coupon interest rate prior to the issue. This guarantees that bondholders will know how much they can earn in the future. If the bond issuer suddenly becomes unable to pay its interest obligations, it is said to be in default. Bond Terms: FACE VALUE, MATURITY DATE, COUPON RATE The face value of the bond is the amount of money the bond issuer borrowed and must be repaid at the end of the loan period. The face value is also called par value or principal. The end of the loan period is called the maturity date. At the maturity date, the bond issuer is required to pay the total amount of the loan borrowed from bondholders. The amount of money earned from a bond is determined by the coupon rate or interest rate of that bond. This is always announced prior to the issue. Most bonds pay semiannual (every 6 months) coupon interest, although there are some that pay quarterly or annually. How exactly an investor earns from bond investing will be discussed in Part 2 of our series on How to Invest in Bonds.

Bond Investing Guide 2: How to make money with Bonds

In Bond Investing Guide 1: What are Bonds? you learned what bonds are, how they differ from stocks, and some jargons associated with bond investing. Here in Part 2, you will learn how to earn from bonds. There are two ways to make money from bonds: through coupon interest and bond trading. In this article, we will only focus on the first method coupon interest and we will defer the discussion of the second method in a later article. What is Coupon Interest Payment? The coupon rate is the interest rate the bond pays. This rate is usually fixed for the duration of the life of the bond, although some bonds pay a floating rate, meaning the interest rate is adjusted based on a benchmark rate. The rate is always quoted in percent, and the interest payment is simply the coupon rate multiplied by the par value of the bond. How to compute the Interest Payment Lets use as example a bond paying a coupon rate of 8% annually with a par value of P100,000. The interest payment can be computed by multiplying the coupon rate of 8% with the P100,000 par value of the bond.

8% x P100,000 = P8,000 Since the bond pays annually, it will pay bondholders P8,000 interest every year until the maturity date.

Annual- vs. Semiannual- vs. Quarterly-Paying Bond If, for example, the same bond pays semiannually rather than annually, it will pay interest twice every year (every 6 months). The annual interest payment of P8,000 will simply be divided into two payments, which means the bond investor will get P4,000 every 6 months. On the other hand, if the bond pays quarterly, the P8,000 annual interest will be divided into four interest payments (to be paid every 3 months). Thus, an investor will receive four payments of P2,000 payable every 3 months. Pros and Cons of receiving Interest early In all of those scenarios, the investor will receive a total of P8,000 interest at the end of every year. In the case of semiannual- or quarterly-paying bond, however, the investor receives part of the interest earlier compared to a bond that pays annually. The investor thus benefits from the time value of money because he or she already gets hold of the money rather than waiting for the end of the year to receive the cash. The risk, on the other hand, is that if the investor wants to reinvest the coupon payment received but interest rates have fallen, the funds can only be reinvested at a lower rate as opposed to the higher rate offered by the original bond. This risk of reinvesting these funds at a lower rate is called reinvestment risk. Reinvestment risk and other risks associated with bond investing will be discussed in Part 3 of our series on How to Invest in Bonds.

Bond Investing Guide 3: Risks in Bond investing

In Part 1, you learned what bonds are while in Part 2, you learned how you can make money with bonds. In this article, you will understand the different types of risks associated with bond investing. Like any other financial instrument, a bond also has risks. Compared to other investment classes such as stocks or real estate, however, the risk in bonds is generally lower. Here are the specific types of risks in bond investing. Reinvestment Risk Reinvestment risk is the risk that the bondholder will reinvest the cash flows received from a bond at lower interest rates. This usually happens when coupon interest payments have been received or when a bond is called or when it is prepaid and interest rates have declined in the economy causing the bondholder to lose out on the higher interest rate of the original bond. Call Risk A specific type of reinvestment risk is call risk, or the risk that the bond issuer will call the bond causing the bondholder to reinvest the payment received at lower rates . Some bonds are callable, meaning, the issuer of a bond has the option to pre-terminate the bond prior to maturity date. This usually happens when interest rates have fallen. Since the issuer can simply make a new bond issue at lower interest rates, it will benefit greatly by calling or preterminating the bond. When this happens, the bondholder receives payment but is now at risk to reinvest the received funds in bonds that pay lower interest rates. Prepayment Risk Another specific example of reinvestment risk is prepayment risk, wherein the bond issuer returns the principal at an early, unscheduled date to take advantage of declining interest rates in the economy. When this happens, the bondholder is at risk to reinvest the returned principal in other bonds that pay lower interest rates. Inflation Risk

Most bonds pay regular coupon payments, in most cases, annually or semiannually. Bondholders may lose on the value of money if the inflation rate in the economy is rising. For example, if the inflation rate in the Philippines rose to 10% from 2008 to 2009, a product being sold for P1,000 in 2008 will now cost P1,100 in 2009. A bondholder receiving P1,000 coupon interest annually wont have the same purchasing power in 2009 compared to 2008. This risk that the increasing prices caused by a higher inflation rate will decrease the amount of real goods and services that bond payments will be able to purchase is called inflation risk. Exchange Rate Risk Exchange rate risk emerges when a bond makes payments in a foreign currency. For a Filipino investor who purchases a bond that pays coupon interest in US Dollar, a depreciation of the Dollar versus the Philippine Peso will reduce the returns to the peso-based investor. For example, if the dollar depreciates from an exchange rate of US$1.00 = Php50.00 to US$1.00 = Php48.00, a peso-based investor receiving coupon interest of $100 annually will receive less money after converting the dollar interest to peso. Downgrade Risk Bonds with high credit rating are generally considered low-risk. If they are downgraded to a lower credit rating, they are assumed to be riskier than before. Investors of a downgraded bond will be faced with a higher risk of default and lower price of the bond. This is downgrade risk. Sovereign Risk Bonds issued by a sovereign entity (more specifically, a country) are almost always low-risk. Thats because they can always raise taxes or print more money just to be able to pay its bond obligations. If, however, the countrys attitude towards repayment changes or its ability to repay worsens, the government bond becomes riskier. This risk is calledsovereign risk. Event Risk Any risk outside the risks of financial markets which can have a sudden and substantial financial impact on the bond issuers financial condition is called event risk. For example, new regulations on clean air requirements, storms that destroyed warehouses, or multi-million dollar theft by the CEO may cause companies to incur losses which can reduce the cash available for bondolders. After learning the risks of bond investing, youre almost ready to make your first bond investment.

Bond Investing Guide 4: Types of Bonds

Youre almost ready to make your first investment in bonds. In Part 1 of this series, you learned what bonds are; in Part 2, you learned how you can make money with bonds; and in Part 3, you understood the risks associated with bond investing. In Part 4 of this series on How to Invest in Bonds, you will learn the different debt instruments you can invest your money in. First, were going to expand our discussion to include not just bonds, but fixed-income instruments in general. Technically, bonds refer to debt instruments with maturities of 1o years or more. Most people, however, use the term bonds loosely to refer to almost any debt instrument regardless of maturity. By Maturity Period A fixed income instrument that matures in 1 year or less is called a bill. A popular example is the short-term debt obligation of governments, usually called Treasury Bills or T-Bills. A debt obligation that matures between 2 and 10 years is called a note. An example is the governments Treasury Note or T-note. As explained earlier, a fixed income instrument that matures in 10 years or more is called a bond. By the Issuer A fixed-income instrument issued by the national government through its Treasury Department is called Treasury Securities. Depending on the maturity period, these may be Treasury Bills (T-bills), Treasury Notes (T-notes, or Treasury Bonds (T-bonds).

Government agencies can also issue bonds to raise funds. Examples of these agencies in the US include the Government National Mortgage Association (GNMA) or Ginnie Mae and government-sponsored enterprises Federal National Mortgage Association (Fannie Mae), Federal Home Loan Bank Corporation (Freddie Mac), and Student Loan Marketing Association (Sallie Mae). In the Philippines, PAG-IBIG or the Home Development Mutual Fund also issues bonds to raise needed capital.

Local government units sometimes also use debt instruments to acquire funds. Municipal bonds backed by the full taxing power of the municipality is called a General Obligation Bond. Bonds issued by the municipality to finance a government project whose interest and principal payments are dependent on the income of that project are calledRevenue Bonds. In the Philippines, examples of municipal bonds are the Puerto Princesa Green Bonds, Boracay-Aklan Provincial Bonds, and Tagaytay City Tourism Bonds. Lastly, a bond issued by a business entity is called a Corporate Bond. As explained in the first article of this series, corporations use bonds as an alternative to stocks in raising capital. Examples of companies in the Philippines regularly issuing corporate bonds include Ayala Corporation, Globe Telecom, JG Summit Corporation, Filinvest Land, and many more. By the Interest Coupon Structure In Part of this series, you learned how a bond investor earns from the regular coupon interest payment. Not all bonds pay regular interest though. A bond that does not pay any interest rate is called a Zero-Coupon Bond. Since investors dont receive interest payments, the only way for them to earn is to buy these bonds at huge discounts so they can profit afterwards when the bonds are redeemed at their par value. Bonds with a stated interest rate but are not paid until maturity are called Accrual Bonds. Investors dont receive interest prior to maturity but they accrue and compound and are paid during the maturity period. A bond that pays an initial interest rate for the first period then a higher rate after that period is called a Step-Up Bond. For example, a 10-year maturity bond may offer 5% fixed interest for the first 4 years then starting on the 5th year, the interest rate is 7%. Floating-Rate Bonds are bonds whose coupon rate is linked to a benchmark rate. This benchmark rate may be the countrys inflation rate, the London Interbank Offered Rate (LIBOR) or other rates. A floating-rate bond, for example, that pays a coupon rate equal to 2% plus the inflation rate will pay 5% if the inflation rate is 3%. If the interest rate is 5%, the bond will pay 7%. More details of each instrument discussed above will be explained in a later article.

What are Retail Treasury Bonds (RTB)?

What are RTBs? The Retail Treasury Bond (RTB) is a fixed-income instrument issued by the government as a way of raising funds. Since it is backed by the Philippine government, it is generally considered a safe and liquid investment opportunity. Why is it called Retail? At a minimum investment of Php5,000 (US$105), individuals can invest here, thus the term retail. The problem, though, is that individuals must usually be an investment banking client of a bank in order to invest and, to become a client, a higher amount of investment is required. Some banks require at least P100,000 investment ($2,083) while some even require at least P1 million ($20,833) or P10 million ($208,333). How do I earn from RTBs? You receive interest coupon payments every quarter. For a detailed example of how the interest is computed, please look at our article on Philippine RTBs issued in 2008. What are the details of the September 2009 RTB offering? The following information about the RTBs has been forwarded to us by a Government Securities Eligible Dealer (GSED) participating in todays auction.

Tenor (Maturity Period): 3 years, 5 years and 7 years Auction Date: September 15, 2009 Public Offering: September 16 23, 2009 Settlement Date: September 24,2009 Coupon Rate: 3 years (Due 2012) 5.25% 5 years (Due 2014)- 6.25% 7 years (Due 2016) 7.00% How can I invest in RTBs? Visit a branch of your bank and inquire if they offer the RTBs. If they know nothing about it, contact directly your banks Trust Group usually located in the banks Head Office. The joint issue coordinators of the RTB offering are Banco de Oro Universal Bank, BPI Capital, Development Bank of the Philippines, First Metro Investment Corp., Land Bank of the Philippines, Metropolitan Bank & Trust Co., and Rizal Commercial Banking Corp. so most probably they know about the RTBs.