Capital market: Strategies of investing in bonds

Rwanda Over-The Counter market first two weeks in business recorded active trading activity. To date, the bond market transacted a total turnover of Frw186 million in 18 deals.

Rwanda Over-The Counter market first two weeks in business recorded active trading activity. To date, the bond market transacted a total turnover of Frw186 million in 18 deals.

The two active debt securities so far are the two 2-year government Treasury bonds that will mature in 2010 with periodic interest of 8 per cent per annum. Treasury bonds transacted in 15 deals worth Frw36 million at prices between Frw99.500 and Frw102.95.

The third is, the 10-year Rwanda Commercial Bank (BCR) bond that will mature in 2017 with periodic interest of 9 per cent per annum was transacted at 100.25 in 3 deals worth Frw150 million CHRISTINE O. ASABA explains how one could invest in bonds.

While reviewing the monetary policy and financial sector development in 2007 and monetary guidelines for the year 2008 on February 21, at Serena Hotel, the governor of the National Bank of Rwanda anticipated the future success in bond investments. The presentation appreciated the results of the capital markets, as having positive indicators of a good prospect to issue bonds with extended duration in order to deal with the current state of excess liquidities in the banking system.

Income

If you are targeting increased interest, you will typically get higher coupons on longer-term bonds. With more time to maturity, longer-term bonds are more vulnerable to changes in interest rates. If you are a buy-and-hold investor, however, these changes will not affect you unless you change your strategy and decide to sell your bonds.

You will also find higher coupon rates on corporate bonds than on Rwanda treasury bonds with comparable maturities. In the corporate market, bonds with lower credit ratings typically pay higher income than higher credits with comparable maturities.

High-yield bonds (sometimes referred to as junk bonds) typically offer above-market coupon rates and yields because their issuers have credit ratings that are below investment grade.

If you are thinking about investing in high-yield bonds, you will also want to diversify your bond investments among several different issuers to minimise the possible impact of any single issuer’s default. High yield bond prices are also more vulnerable than other bond prices to economic recession, when the risk of default is perceived to be higher.

Stock, bond markets

Because stock market returns are usually more volatile or changeable than bond market returns, combining the two classes of asset can help create an overall investment portfolio that generates more stable performance over time. Often but not always, the stock and bond markets move in different directions: the bond market rises when the stock market falls and vice versa. Therefore in years when the stock market is down, the performance of bond investments can sometimes help compensate for any losses. The right mix of stocks and bonds depends on several factors.

Definite future goal

Perhaps you know that in some years to come, you will need a down payment for your planned asset example a retirement home. Because bonds have a defined maturity date, they can help you make sure the money is there when you need it.

Zero coupon bonds are sold at a steep discount from the face value amount that is returned at maturity. Interest is attributed to the bond during its lifetime. Rather than being paid out to the bondholder, it is factored into the difference between the purchase price and the face value at maturity.

You can invest in zero coupon bonds with maturity dates timed to your needs. The value of zero coupon bonds is more sensitive to changes in interest rates however, so there is some risk if you need to sell them before their maturity date.

Why sell a bond before maturity

Investors following a buy-and-hold strategy can encounter circumstances that might compel them to sell a bond prior to maturity for the following reasons:

They need the principal. While buy-and-hold is generally best used as a longer-term strategy, life does not always work out as intended. When you sell a bond before maturity, you may get more or less than you paid for it. If interest rates have risen since the bond was purchased, its value will have declined. If rates have declined, the bond’s value will have increased.

They want to realise a capital gain. If rates have declined and a bond has appreciated in value, the investor may decide that it’s better to sell before maturity and take the gain rather than continue to collect the interest. This decision should be made carefully, as the proceeds of the transaction may have to be reinvested at lower interest rates.

They need to realise a loss for tax purposes. Selling an investment at a loss can be a strategy for offsetting the tax impact of investment gains. Bond swapping can help achieve a tax goal without changing the basic profile of your portfolio.

They have achieved their return objective. Some investors invest in bonds with the objective of total return, or income plus capital appreciation or growth. Achieving capital appreciation requires an investor to sell an investment for more than its purchase price when the market presents the opportunity.

Total return

Using bonds to invest for total return, or a combination of capital appreciation (growth) and income, requires a more active trading strategy and a view on the direction of the economy and interest rates. Total return investors want to buy a bond when its price is low and sell it when the price has risen, rather than holding the bond to maturity.

Bond prices fall when interest rates are rising, usually as the economy accelerates. Within different sectors of the bond market, differences in supply and demand can create short-term trading opportunities.

Various futures, options and derivatives can also be used to implement different market views or to hedge the risk in different bond investments. Investors should take care to understand the cost and risks of these strategies before committing funds.

Some bond funds have total return as their investment objective, offering investors the opportunity to benefit from bond market movements while leaving the day-to-day investment decisions to professional portfolio managers.

sebasore@yahoo.com

 

Have Your SayLeave a comment