MOST investors in Malaysia may not be familiar with bond investing. We may have come across bond funds in our unit trust funds investment, but, not many really understand why and how to invest in bonds.
A bond is basically a loan to government units or corporations that issue the bond. When you invest in bonds, you become the lender to the issuers. In return, you will periodically be repaid a pre-specified percentage of interest for the use of your money and when the bond reaches the maturity date, the principal that you invested earlier will be paid back to you.
For example, if you have invested in Bank Negara’s Bond Simpanan Merdeka 2009, which has three-year tenure and pays 5% of interest per year, you will receive a stream of interest income on a monthly basis and at the end of the third year, you will also get your principal back.
However, bond funds differ from individual bonds in many ways. While the interest income from the fund changes over time, the interest payments from individual bonds are usually fixed.
As a bond fund is made up from a pool of bonds, it usually does not have a fixed maturity and its yield is based on current income relative to its net asset value (NAV) while individual bonds are quoted in current yield or yield-to-maturity. In addition, bond funds normally make interest distributions monthly or quarterly, whereas individual bonds pay interest semi-annually.
The main purpose of investing in bonds or bond funds is to provide portfolio diversification, which in effect, helps lower your overall investment portfolio risk.
In general, bond funds have lower risk compared with equity investment and normally, bonds have low correlation with equity investment. While equity tends to perform well in high inflation rate and high interest rate environment, bond performance is unsatisfactory under such circumstances.
However, when the economy is bad and equity is not performing well, a lower interest rate tends to spur the economy, and at the same time, benefits bond returns. So, in most periods, it has negative correlation with equity interest.
The price movement of a bond is driven by a few factors. However, the main determinant is the interest rate. When the prevailing interest rate goes up, the price of the outstanding bonds will fall and vice versa. Therefore, the highest risk in bond investing is also the interest rate risk.
Duration is a measure of interest rate risk, which is defined as the weighted-average time it takes for a bond to pay back its interest and principal. By taking the duration of a bond or a bond fund times the change in interest rates, you will get the approximate percentage change in the bond’s price or the bond fund’s net asset value.
For example, if a bond fund’s duration is 10 and interest rates fall (or rise) by 0.5 of 1%, the fund’s NAV will increase (or decrease) by about 5%. As the duration of a bond is its average maturity, it measures interest rate risk.
When the inflation rate of a country increases, it will also result in higher interest rates to counter the inflationary pressure. Due to the recent global financial crisis, countries like China implemented stimulus packages, which in turn caused these countries to face potential inflationary pressure from higher asset prices.
Given that some economists have predicted that our interest rates may go up again, it is safer to buy bond funds with shorter duration because the bond funds will suffer a lower drop in prices with higher interest rates.
Other than interest rate risk, investors must also be aware of any potential credit risk of the bonds held by the bond funds, which is the possibility of the issuer failing to meet its obligations under the indenture or the risk of a bond being reclassified as a riskier security by credit rating agency.
It is a major problem during economic crisis or financial crisis, especially in the case of corporate bonds. However, given that our economy is currently at its recovery stage, credit risk may not a major issue.
As investors, before we invest in any bonds or bond funds, we must at least make the effort to understand the basic characteristics of the bonds that we are going to put our money in. Even though it is said to be safer than equity investments, there are still certain risks inherent in bonds investments that we must be aware of.
The Star, Wednesday February 24, 2010
Personal Finance, Planning and Management to Wealth Creation
At Clic Finance, you are not going to find any get-rich-quick schemes nor multi-level marketing things for wealth creation. Instead, I will be sharing the information on personal finance knowledge and related topics.
I am personally love to acquire knowledge and skills in personal finance hoping to find answers to deal with debts, how to get out of it fast and how to manage loans to wealth creation and so on.... I could said there are people who get rich quickly, but the fact is almost anyone can get rich slowly and patiently.
In your journey to wealth creation, Don’t become obsessed with money and wealth. Always Remember! Money does gives you more options, but happy and balanced life makes your life worth living. Having lots of money does not guaranttee/mean your happiness in life. You happiness come the moment you receive the services or values that money can bring you.
Learn to have a balanced happy life in wealth creation with proper saving, investment strategies and spending planning.
May be by now you are asking youself: "How I am going to start or achieve it?"
It's simple, Take your actions now and remember failure is ok. A thousand mile journey always start with the 1st step. The sooner you determined to start moving toward your goals, the easier they are to reach. Everybody makes mistake, the important point here is, have you learned anything from it. Every mistake encountered makes you stronger and get closer to the door of success. It would be better to fail once than you have never tried it.
Lastly please note that everything you read here is my own informed opinion. Never believe everything you read, and always form your own conclusions.
Thank You.
I am personally love to acquire knowledge and skills in personal finance hoping to find answers to deal with debts, how to get out of it fast and how to manage loans to wealth creation and so on.... I could said there are people who get rich quickly, but the fact is almost anyone can get rich slowly and patiently.
In your journey to wealth creation, Don’t become obsessed with money and wealth. Always Remember! Money does gives you more options, but happy and balanced life makes your life worth living. Having lots of money does not guaranttee/mean your happiness in life. You happiness come the moment you receive the services or values that money can bring you.
Learn to have a balanced happy life in wealth creation with proper saving, investment strategies and spending planning.
May be by now you are asking youself: "How I am going to start or achieve it?"
It's simple, Take your actions now and remember failure is ok. A thousand mile journey always start with the 1st step. The sooner you determined to start moving toward your goals, the easier they are to reach. Everybody makes mistake, the important point here is, have you learned anything from it. Every mistake encountered makes you stronger and get closer to the door of success. It would be better to fail once than you have never tried it.
Lastly please note that everything you read here is my own informed opinion. Never believe everything you read, and always form your own conclusions.
Thank You.
Friday, March 12, 2010
Subscribe to:
Post Comments (Atom)
Posts
No comments:
Post a Comment