Some people misunderstand that bonds are when we borrow money to invest. Some people are investors but are still confused about “bonds” and “stocks”. What is the difference?
This article will take us to understand what bonds are first.
Bonds are a type of debt instrument, which is a loan agreement between a person seeking capital (the issuer of the instrument or the debtor) and an investor (the holder of the instrument or the creditor).
The name of debt instruments varies depending on who issues them. For example, if a private entity issues a bond, it is called a “bond”. If the government issues a bond, it is called a “government bond”.
For example, if ABC Company is a private company and wants to borrow money to expand its business, if the company does not borrow from the bank, the company can issue “bonds” and offer them for sale to interested persons or organizations.
We can buy bonds from ABC Company, and when we buy them, we will immediately become a “creditor” of ABC Company, while the Company will immediately become our “debtor”, that is to say:
- The issuer of bonds will have the status of a debtor.
- Those who purchase bonds will have the status of creditors.
What is the difference between “bonds” and “stocks”?
If we buy bonds, we will become a “creditor of the company” and will receive interest as a return. When the bonds mature, we will receive the principal back.
But if we buy shares of the company, we become “joint owners”. If the company makes a profit, we may receive dividends (depending on the company’s policy on how dividends will be paid). And if we sell when the share price is higher than the price we bought it at, we may profit from the price difference.
How do “bonds” provide returns?
Bonds are considered a type of investment. We will know in advance how much return we will receive, how many times per year we will receive the return, and when we will receive the principal back.
For example, on January 1, 2018, we invested in the bonds of ABC Company with 100,000 baht. The bonds will provide a return (interest) of 6% per year, with returns paid twice a year. The bonds have a term of 6 years.
This means that we will receive a return of 3,000 baht in the first 6 months (1 July 2018) and another 3,000 baht in the last 6 months (1 January 2019) throughout the life of the bond, which is 6 years.
When the bond’s life is 6 years, we will get back the principal we used to buy the bond for 100,000 baht, plus the return over the 6 years of 36,000 baht. If we want to sell the bond before the 6 years are up, we may have to find a buyer ourselves or trade on the secondary market, such as BEX of the Stock Exchange of Thailand.
Are there risks in “bonds”?
When we deposit in a bank, we get interest, but the interest we get is very little, but in exchange for low risk.
But if we invest in bonds, we will get more interest than bank deposits, but we also have to exchange for higher risks. The risk that may occur is the “risk of not getting the money back (Default Risk)”.
Because there is a chance that the company will default on our debt, such as having financial problems or having a chance to default on the debt because of breaching the terms of the contract, which will cause the company to be unable to find the principal or interest to pay to the bond buyers on schedule.
That is why there is a need to prioritize risks by looking at Credit Ratings. In Thailand, there are two credit rating companies, or as people often call them, CRAs (Credit Rating Agencies) that the SEC has approved: TRIS Rating Co., Ltd. and Fitch Ratings (Thailand) Co., Ltd. They are divided into two main groups as follows:
- The group with high credit rating, low risk and low return are called Investment Grade Bonds, which are BBB and above (BBB, A, AA, and AAA).
- The group with low credit rating, high risk and high return are called High-Yield Bonds such as D, C, B, and BB.
Of course, the group with a high credit rating or Investment Grade has a lower risk of default, but the return is also lower, according to the principle of “high risk high return”.
In summary, the guideline for choosing to invest in bonds is that the higher the credit rating (many A’s), the lower the risk of default.
However, credit ratings can change if there are factors that affect the company’s ability to repay debt. Therefore, investors must continuously monitor the bonds they invest in and must also see whether the credit rating belongs to the issuer or the instrument.
And did you know that there are some types of bonds that are not rated? “Unrated Bonds” are bonds that we cannot look at the risk from the Credit Rating. These types of bonds are offered to “Accredited Investors” only and require a lot of knowledge and understanding.
In addition to the risk of default, investing in debentures also has the risk of liquidity in trading if the debentures do not have a secondary market or there are not many people wanting to buy or sell, which will result in not being able to sell at the desired price or within the desired time.
Who are bonds suitable for?
Suitable for those who are interested in long-term investment, such as more than 4-5 years or more, because most bonds have a long contract period.
And must be the type of investor who already has savings but likes to invest in something that is not flashy, can accept less risk, focuses on receiving consistent returns, expects a profit that is not much but must be higher than the interest on deposits. But don’t forget that all types of investment have risks. No investment is 100% safe, but in exchange for the opportunity to get higher returns)
Bonds come in many types, both plain and complex, and have different returns and risks. For example, “perpetual bonds” have conditions that the investor must hold indefinitely, with the issuer giving them the option to redeem them before maturity (call option). With many conditions, they tend to offer high returns.
Before investing, we must study the conditions carefully, which can be read further in the prospectus or by visiting the SEC website > www.sec.or.th.
What are bonds? So are they really an investment?
