What is a bond
A bond is a debt security, which is mainly issued for a limited time.
There are two sides to a deal:
Issuer - structure, which issued these securities to raise additional capital. The issuer is obliged to return the borrowed amount to the bondholder and pay a certain percentage (coupon), if provided by the prospectus.
Investor - buying bonds of the issuer, essentially provides its own funds for temporary use and receives income for this.
The investor chooses a bond circulation period that is comfortable for his investment purposes (Short term, mid-term, Long term). Specific conditions, namely the par value of the paper, periodicity of interest payments (coupon) and timing, determined at the time of issue.
How does a bond work
To carry out transactions with bonds, you can open a brokerage account and make a deal.
By the type of income, bonds are interest and discount.
The most common type of bond, traded on Russian stock exchanges, interest bearing bonds - the issuer pays periodic interest (coupon) during the bond circulation period. Coupons can be paid annually, quarterly or monthly depending on the terms of the paper.
Interest-bearing bonds can be:
• Fixed Coupon - a certain percentage of face value is paid at predetermined intervals. The interest rate on a bond is known from the date of issue and, usually, the same for the entire circulation period of the paper. For such paper, you can make schedule coupon payments with exact amounts and uniquely calculate the yield to maturity.
• With a variable coupon — the coupon is fixed until the date of the offer, after which the interest rate changes depending on market conditions. The new interest rate is unknown before the offer. This mechanism allows the issuer to reduce the interest rate risk., especially if the issue is placed during a period of high interest rates with the prospect of lowering them. And the investor has the opportunity to early redeem these bonds under the offer. In the intervals between offers, such securities are no different from bonds with a fixed coupon, with the only difference, that the profitability is not correctly calculated by the maturity date, and by the date of the next offer.
• With a floating coupon - the interest rate is tied to the change in some indicative financial instrument. For example, to the key rate of the Bank of Russia, consumer price index, items RUONIA, dollar exchange rate, etc.. Usually, you can calculate the coupon size for such securities no further than, than one coupon period. The calculation formula is published by the issuer and is available to all investors. Disadvantage - future profitability can only be predicted. Advantage - allows you to insure, for example, from a sudden change in market interest rates.
discount (zero coupon) bonds - no coupon payment. Initially placed below par. The investor's income is the difference between the purchase price of the paper and the redemption/sale price.
Classification by type of par value redemption
• Redemption of the par in full at the end of the term. By default, the face value is paid to the investor in full on the maturity date of the bond. This type of redemption is the most common among securities on the Moscow Exchange..
• Bonds with indexed par value. Sometimes the coupon is not floating for a bond, and the face value of the paper. This type of OFZ has advantages in times of high inflation or as insurance against future acceleration in price growth..
• Bonds with depreciable debt. For most bonds, traded on the Moscow Exchange, the nominal amount is paid to the investor in full on the maturity date. However, the issuer may be uncomfortable with this form of borrowing., at which, by the maturity date, a large amount of money will have to be accumulated to redeem the issue. Then he issues a bond with depreciable debt, the face value of which is redeemed in installments along with coupon payments. This allows the issuer to distribute the debt repayment evenly over the entire circulation period.. Often such securities are found among municipal bonds.. This type of repayment is less profitable for an investor.: after receiving a part of the face value, the following coupons are charged on the balance of the paper value, resulting in less total income. However, this type of bond can be handy during periods of low interest rates., when are they expected to rise. Then the returned part of the denomination can be reinvested at a higher percentage..
Types of risks
Bond prices may change depending on the macroeconomic situation and events, affecting the activities of the issuing company. The investor should be aware of the possible risks when investing:
Default risk. Fixed in case, when the issuer fails to meet financial obligations under the securities and declares itself bankrupt. In this case, the investor may lose the invested money: unlike deposits, they are not protected by the deposit insurance system.
Bonds are not identical in terms of credit risk depending on the type of issuer. State-owned, sub-federal, municipal, corporate bonds.
• Government bonds - the issuer is the state represented by the Ministry of Finance of the Russian Federation. The most common securities in this category are federal loan bonds. (OFZ): usually have relatively high liquidity, a wide range of investment terms, low probability of default of the issuer. Among the shortcomings, we can note the low profitability., which is compensation for low credit risk.
• Corporate bonds are debt securities of individual companies. They are distinguished by a large, than under OFZ, profitability. Often the coupon for them is variable.
• Sub-federal and municipal bonds. Issuer - constituent entities of the Russian Federation (sub-federal) and municipalities (municipal). The market for these bonds is small, which affects liquidity. At the same time, the yield of securities is slightly higher due to lower reliability.. It is incorrect to buy regional bonds due to higher yields and consider them equal in reliability to government bonds.
inflation risk. Profit on securities and actual income should be adjusted for inflation. In an unfavorable economic situation, there is a risk of negative real profitability, when the interest received does not cover inflation. Long-term investments are more prone to inflation, rather than short-term.
Interest rate risk. Observed when the average market rate for bonds with similar conditions grows. Below Market Interest Bonds Reduce Investor Returns. For this kind of risk, usually, influenced by the key rate of the Central Bank of the Russian Federation. The longer the bond is in terms of maturity, the more its price depends on changes in interest rates.
Reinvestment risk. Assumes the reinvestment of received income (coupons) at a reduced interest rate compared to the purchased. This risk manifests itself when interest rates fall over a long period..
Currency risk. Investing can take place both in the Russian ruble, and in euros or dollars. Investing in foreign assets is highly dependent on currency fluctuations.
According to the legislation, all payments on the territory of the Russian Federation are carried out in rubles. The vast majority of bonds, circulating on the domestic market and available to a private investor, denominated in national currency. Trading takes place mainly on the Moscow Exchange.
Bonds, denominated in foreign currency (mainly in euros and US dollars), called Eurobonds. The main trading volumes of Eurobonds take place on the OTC market, some papers are also available on the Moscow Exchange.
Credit risk. An important indicator when analyzing bonds is the credit rating.. A decrease in the issuer's solvency is reflected in its reputation in the securities market and the price of the bond.
A credit rating is an assessment of an issuer based on a comprehensive analysis of a company, taking into account the financial condition, quality of corporate governance and level of business risks. The agency forms an opinion on the creditworthiness of the company as a whole or in relation to its specific obligations. As a matter of fact, assigning a rating, the ability of the bond issuer to fulfill its financial obligations under these bonds is assessed, that is, repay them on time and pay income on them.
Different bond issues may have different ratings, even for the same company. And the absence of a credit rating of the issue means the absence of the opinion of the credit rating agency on the credit risk of this bond issue..
The rating scale is a system of rating categories, reflecting the Agency's opinion on the probability of default. Expressed in letters and symbols, from the highest level of reliability (for example AAA) down to the lowest (SSS). There is no single global or even all-Russian rating system. However, the credit ratings of different agencies, especially high, usually comparable to each other.
Together with the rating, the agencies publish a forecast for it.: for example, "stable", "Positive" or "negative". He shows, do analysts expect, that the financial position of the organization will change in the coming year and in what direction.
The agency reviews the rating of a particular company on a regular basis.
Liquidity of bonds
Liquidity is the ability of an asset to be bought or sold at market price quickly and without loss in value.. When choosing a bond, an investor should pay attention to the liquidity indicator.
Liquidity risk is the likelihood of not selling bonds before expiration at a fair price. Especially, if an investor decides to urgently sell his bonds, there may simply not be a buyer. This risk is possible given the low awareness of the issuer and a small number of transactions with its debt securities..
Bonds can be categorized into:
– Highly liquid bonds are bonds, which can be sold without reducing their price;
– Low liquid and illiquid - unlikely to sell in a short period of time, without reducing their cost.
What else should you pay attention to when assessing liquidity
• Average daily turnover of trades — the more transactions on a bond take place during the day, the larger the volume of securities an investor can sell in a short time.
• Turnover, including only large transactions - according to some theories, turnover separately by category of transactions may be more indicative for assessing liquidity, than the value of the total turnover.
• Number of days without transactions - the greater the number of such days, the less liquid the bond
• Issue volume - the more securities are in circulation, the more likely it is to realize the required volume through trading on the exchange.
• Credit risk - often riskier high yield bonds are more subject to speculation, respectively, trading activity on them is higher and higher liquidity.
• Volatility - increased volatility can also positively affect the trading volume and liquidity of the bond.
• Publicity of the issuer - the more the company discloses information about its activities, the more attractive are its securities.
• Embedded options in the bond - such features, how convertibility, the presence of put / call offers and other options can also affect the bond's liquidity.
What taxes does the owner of bonds pay
Taxation of transactions with securities is regulated by article 214.1 parts 2 Of the Tax Code of the Russian Federation. The tax rate on personal income of residents of the Russian Federation is 13%.
C 2021 G. coupons for all bonds without exception, including OFZ, municipal and corporate, regardless of the date of issue and the value of the coupon rate are included in the tax base and are taxed at the rate 13% (15% when total income is exceeded 5 RUB million). The tax agent is broker.
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