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Bonds

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What is a bond

Bonds are debt instruments issued by governments and corporations when there is a requirement to raise money. They represent a promise by the issuer to the buyer to repay the principal or face value of the bond at a future date. Buyers are compensated by regular predefined coupon payments, usually twice annually.

 Why invest in Bonds 
Bonds provide a predictable cash flow. The dates and coupon percentages are predefined and if held to maturity the buyer realises the Yield to Maturity that the bond was bought at. The Yield represents the total return if held to maturity. Bonds are often considered less volatile and less risky than other asset classes. Bonds tend to offer a higher return than savings rates at banks. Portfolio diversification is another important reason to consider including bonds in your portfolio.
 Can bond prices change 
Most certainly as their prices are a function of interest rates, bond prices have an inverse relationship to interest rates and like other asset classes can change. One can profit from buying when prices are low (yields are high) and selling when prices are high (yields are low) so one will face market risk when invested in bonds.
 Am I locked in when I buy bonds in my EasyEquities account? 

No, EasyEquities will show you prices that will allow you to buy and sell whilst the market is open.

 What happens at maturity? 
South African Government bonds have a predetermined and published maturity date. Depending on the quantum in issue of the maturing bond, the issuer can decide to mature it in 3 tranches over three years. This route is chosen especially when there is a large issue that requires the repayment to be spread out rather than concentrated. If this applies, then a third is normally repaid in cash a year before the published maturity date, a third on the published maturity date and the last third a year after the published maturity date. The second and third repayments are normally paid in new bonds that are issued.
 What is the Yield to Maturity of a bond? 
The yield to maturity is the rate that your holding will yield over the lifetime of your Bond. There is an inverse relationship between a bond’s yield to maturity and the price. If the yield goes up the price will go down and vice versa. Various economical internal and external factors e.g. the inflation rate, GDP, the currency etc. will influence the yield to maturity on a daily basis.
 What is coupon of a bond? 

The coupon rate of a vanilla bond is a fixed rate that the issuer agrees to pay the buyer at regular intervals, normally semi-annually. It is expressed as a percentage of the bonds face value. The coupon is set when the bond is issued and remains constant for the term of the bond. If a bond’s coupon is 10%, it will pay 5% every 6 months.

 How is the coupon distribution calculated?
Assuming you held 1000 units (also known as nominal or face value) in a specific bond that has a coupon of 10% p.a., as at 14 days (or more) prior to the published coupon dates, you would receive R50 every 6 months. This is calculated by taking your position of 1000 multiplied by the coupon (10%) / 2 (as they are paid semi-annually).
 At what date do you need to hold the bond in order to qualify for the coupon? 
The coupon accrues daily and forms part of the dirty price, however in order to receive the cashflow from the coupon distribution, the buyer needs to hold the bond as at close of business 14 days prior to the published coupon date. If the bond’s coupon dates are 21 June and 21 December, you would have to own the bond on close of business of 7 June and 7 December.
 What happens to a bond’s price when the coupon is paid? 

When the coupon is paid, the bond price will decrease, like the price of an equity when a dividend is paid. 

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