What are bonds and how to make money on them

How Bonds Work

Buying bonds, you lend money to the government or business for a certain period of time. After this period, the issuer, that is, the recipient of your funds, returns you the par value of the securities. And in addition, it periodically pays coupon income - interest for using your money.

The denomination is a fixed amount. The dates of coupon payment are also known in advance. But its size is a little more complicated. The coupon can be fixed and variable. In the first case, this is a percentage established once and for all. In the second, the interest rate depends on some indicator, for example, the refinancing rate.

Bonds can be purchased when placed with an issuer. At this point, they are usually sold at or slightly above par. Also, securities - and this is an important difference from a deposit - can be bought and sold on the exchange until they mature. But here the value is no longer the denomination, but the market value. It can change depending on inflation, coupon interest, financial indicators of the issuer and other factors. Coupon yield is given to the person holding the bond at the time of payment.

Accordingly, if you buy a bond, you can only earn on coupon yield or sell profitably a security that has risen in price. Or you can buy it off-hand when the market value has dropped, and then make money on the coupon yield and at maturity.

What are the bonds

State

These securities are issued by the state. For example, in Russia, the Ministry of Finance issues federal loan bonds (OFZ).

In most cases, government bonds help protect savings from inflation and earn some money.

According to Nikolai Klenov, financial analyst at Raison Asset Management, they are considered reliable, but their yield is only slightly higher than a bank deposit. This is due to minimal risks: the state can not pay off the debt on bonds only if it declares itself bankrupt. This rarely happens, although it still happens. In Russia, there was a default in 1998. Over the years, it was announced by Argentina, Brazil, Sri Lanka, Venezuela and other countries.

In order not to become hostage to such events, it is worth investing only in bonds of states with stable economies. However, a surprise may await a novice investor here: the bonds of such countries as Germany, Switzerland, Denmark, Japan have negative yields. Buying their securities, investors do not seek to earn, but simply keep most of their savings in a stable currency.

Nikolay Klenov financial analyst at Raison Asset Management investment management company

Russian OFZs, according to the expert, show good yields compared to EU or US bonds: for two-year OFZs, it is 4.5%. However, Russian bonds have serious currency risks. If the ruble falls, the OFZ yield in terms of dollars or euros may turn out to be negative.

OFZs denominated in foreign currencies can be insured against this risk. They are called Eurobonds. However, they have their drawbacks: a high entry threshold and a sell price that is much higher than par. For example, a RUS-28 bond (dollar OFZ maturing in 2028) is worth $ 1,715 today, while its face value is $ 1,000.

Municipal

These bonds are similar to government bonds, only they are issued by city or regional authorities. For example, in Russia the Kaliningrad and Saratov regions have their own securities, but not only.

With municipal bonds, things are about the same as with government bonds.

Corporate

Loans can be given not only to the state, but also to business. The yield on corporate bonds is higher, but the risks, accordingly, are also higher, because companies go bankrupt more often than states.

However, in general, corporate bonds are a fairly reliable investment: a business can refuse payments on them only if it declares itself bankrupt. In order not to run into default, before buying corporate bonds, an investor should study the company's financial statements for several years. You should also find out the credit rating of the company and analyze the history of the bond - how its price has changed over time.

Nikolay Klenov

According to the analyst, the most reliable issuers of corporate bonds are "blue chips" - large companies with large capitalization. These are, for example, Microsoft in the USA and Gazprom in Russia. The yield on bonds of reliable corporate issuers is higher than that of government bonds, but not by much.

There are also so-called junk corporate bonds - with high yields, but a high risk of default by the issuer. For ruble-denominated securities, the maximum yield on junk bonds is about 15%, for dollar-denominated securities - about 11%. If successful, the investor can make good money. But he also risks being left without money at all. When investing in high yield bonds, it is necessary to carefully analyze the financial statements and the credit rating of the company.

What to look for when choosing bonds

There are several important parameters to consider.

Profitability

How much can you earn if you don't sell bonds and wait for them to pay off.

Coupon size

Interest rate on your "deposit".

Bond value

An important factor to understand if you can afford to invest in principle.

The minimum lot for some bonds can be between one thousand rubles and one thousand dollars. And for some - 10 thousand or 200 thousand dollars.

Gennady Salych Chairman of the Board of Freedom Finance Bank

Duration

This is the maturity date of the bond. The longer it is, the greater the risks in terms of changes in the key rate, inflation and other factors that can affect profitability.

Fixed or floating interest rate

According to Gennady Salych, Chairman of the Board of Freedom Finance Bank, if it is fixed, then you will not face a sharp change in the coupon yield due to the decision of the issuer's management or when the market indicator to which the coupon is linked. It is better for a novice investor to choose just such bonds.

Currency

Obviously, you need to choose the one that you find more profitable for an investment after you read the courses and opinions of analysts and connect your flair if you feel that you have it.

Subordinated paper or not

Subordinated securities, or securities of the second order, carry slightly higher risks. Payment for them occurs after the transfer of money to the holders of the first level. Therefore, if you are not ready to take risks, do not take subordinated bonds.

Possibility of an offer

As Gennady Salych notes, the offer allows the owner of the bond to present it to the issuer for early redemption at a pre-agreed price. This can be useful if for some reason you do not want to wait until maturity.

Credit risk

That is, an estimate of the chances that your issuer will go broke and leave you without money. Pay attention to the company's profit, the ratio of equity to debt, and so on. To do this, you will have to do a little research and study the information in the public domain.

How to buy bonds

To do this, you need to open a brokerage or individual investment account. How to do this and what to look for is described in detail in the material on IIS.

What is the bottom line

Summary from financial analyst Nikolai Klenov:

Bonds are more reliable than stocks. They have a fixed income.
The investor may not receive this yield if the issuer declares a default. Therefore, you need to properly choose where to invest.
The most reliable issuer is a state with a stable economy, the average in terms of reliability is a corporation with a good credit rating, the most risky is a young company with no clear history in the debt market.
Since the principle “the higher the yield, the higher the risk” is applied on the exchange, the bonds of the most reliable issuer will have the minimum yield.