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Chirag a veteran in Digital Marketing, Currently working with SJS Group.
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Wealth Management
  • Trading And Investing In Bonds 0 comments
    Dec 10, 2012 5:38 AM

    Trading and investment in bonds has been an integral part of generating fixed returns for retail and institutional investors such as financial institutions, pension funds, mutual funds etc. The fixed nature of the return is due to fact that an investor can lock a yield as per its appetite, at the beginning of the investment period, based on relative value. However, it is imperative to analyze the return from a risk and reward perspective. For instance, an investment into an investment grade bonds usually offer lower yields, but better credit quality. On the other hand, junk bonds can offer higher return but at a higher risk. In this context, fixed income research become very crucial as its helps in identifying the credit quality of an issuer and at the same time identifies opportunities arising out of any mis-pricing. In addition to corporate issuers, bonds are being issued by sovereigns and quasi sovereign entities. Majority of trading in case of bonds takes place at institutional level, but retail investors can also invest through wealth management services provided by the brokerage and advisory firms. At institutional level, trading in bonds is usually done by the fund management and portfolio management firms. Funds usually operates on mandates requiring them to invest in a category of bonds - investment grade, high yield, sovereign with a focus on geographies - Asian, Mena, emerging markets etc. There is stark contrast between trading and investing in bonds. An investment in the bond is regarded as a low risk decision, whilst trading in the same could be highly risky. Trading in bond is more commonly seen in the institutional space, whereby short terms gains are made based on movements in the inputs responsible for the movement in the bond yields. The broad categories of inputs that could impact a bonds price/yield are movement in the interest rates, relative valuation and credit quality of the bond issuer. While analyzing bonds, in addition to their own analysis, investors usually refer to credit opinion of rating agencies. S&P,Moody's and Fitch are the key global rating agencies, in addition to various other rating agencies. The rating can provide an investor with some of the key underlying issues with a bond issuer. However, one of the draw back of ratings could be its reactive nature, which may not be that helpful while bond trading but will definitely help in an investment. In addition to above considerations, an investor needs to understand certain nomenclature for bonds. Most common being the understanding of difference between par, discount and premium and early redemption risk through call and put features. In addition, a detailed analysis of terms under the prospectus would be required to understand important features such as security, ranking, guarantor, subordination and covenants. Unlike shares, bonds usually trade over-the-counter. However, in advanced economies such as the US, certain bonds are listed on exchange. Also, the derivatives on bonds usually trade on exchanges. Bond Trading is typically done through a dealer, also known as market maker. A dealer has bond traders who maintain the list of available buy or sell quotes for a bond. This is very important in maintaining liquidity in the bond market. A typical ticket size during a trade could be under $1 mm (usually a small ticket), but there are no restrictions as far as size is concerned. From the perspective of trading, an investor needs to consider the bid offer spread (or liquidity), spread over government or other comparable names etc.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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