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What is a Bond?
Bonds are credit notes issued by governments, corporations or other entities to raise funds.
Bondholders are extending credit to the issuer and in return, the issuer commits to redeem the bond upon maturity and to
pay a specified rate of interest (excluding zero-coupon bond) during the life of the bond.
Types of Bond
Classified by the type of issuers:
Government Bond
It is a bond issued by a government. Examples of these types of bonds are Hong Kong Exchange Fund Notes and US Treasury Bonds.
Quasi-government Bond
It is a bond issued by corporations wholly-owned by government or corporations with government as the major shareholder, such
as the MTR and the Airport Authority.
Corporate Bond
It is a bond issued by corporations like Hutchison Whampoa
and Cheung Kong Holdings.
Supranational Bond
It is a bond issued by an entity which comprises a number of central banks or government financial
authorities, for example, the World Bank and the Asian Development Bank.
Classified by the type of interest payment:
Fixed Rate Bond
A bond that offers a fixed rate of interest, which remains unchanged throughout the life of the bond.
Floating Rate Bond
A bond that offers a coupon rate that is adjusted periodically along with changes in a benchmark yield
such as HIBOR or LIBOR.
Zero-coupon Bond
A bond that offers no coupon interest. It is sold at a discount to par value. Investors earn capital
gain as the bond price moves towards par over time.
Pros and Cons of Bond Investment
Pros:
Steady Return
Similar to bank deposits, bonds generally offer a designated interest income and repayment of principal. Bond prices also
have the potential to increase.
Risk Diversification
Owing to its steady return and low risk characteristics, trading in bonds is a good way to diversify investment risks.
Complete Investment Portfolio
Bonds provide a stable return. Investors can complement bonds to other investment tools (for example equities) within
their investment portfolio according to their needs and risk acceptance levels.
Cons:
Risk
Early redemption of the bonds may result in a loss of bond prices drop.
The Relationship of Bond Yield, Bond Price and Time to Maturity
Bond Yield
The issuer will designate a fixed interest rate called coupon rate; the annual total interest amount is calculated based on
the coupon rate and the face value of the bond. However, as the bond price may be different from the face value, bond yield
- which takes the bond price and the coupon rate into consideration, is adopted as the measure of return on bond investment.
Bond Price
Bond prices will fluctuate based on the issuer's credit ratings assigned by international rating companies. Moreover, the
bond price and the yield move in opposite direction. When the bond price increases, the yield drops, or when the bond price
drops, the yield increases. In general cases, bond yield and interest rate level move in the same direction.
Time to Maturity
Usually the longer the time to maturity, the higher the risk and bond yield.
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