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Risks and benefits

ASX quoted bonds may provide a steady stream of income and can be an alternative to term deposits. Like any investment, bonds have risks you need to understand before trading. You should obtain independent advice from a professional adviser before making a decision

Potential benefits of investing in bonds

Security

Depending on the issuer, bonds can provide greater certainty that principal will be repaid at maturity than other investment products.

Regular income

For investors who need a predictable source of income, such as retirees, a bond’s regular interest payment can provide greater income certainty than other investment products.

Performance

A better interest rate may be available from some bonds, such as corporate bonds, than from other investments such as term deposits.

Liquidity

Some bonds can be easily traded on ASX, which may allow you to access your funds before the end of the bond term. The ASX also offers a market making incentive scheme to promote liquidity in the Australian government bond market.

Diversification

Bonds can help to diversify an investment portfolio. In some circumstances, they can reduce overall risk or can be used to help manage the risk created by exposure to high growth assets like shares.

Potential risks of investing in bonds

Any investment carries risk. Bonds that are perceived to have higher risk will generally attract a higher coupon rate, while bonds that are perceived to have lower risk (such as government bonds) will generally attract a lower coupon rate. Some key risks to consider when investing in bonds are interest rate risk, credit risk and liquidity risk.

If the coupon rate on a bond is floating, the yield on the bond can be expected to stay in line with current interest rates, so movements in interest rates generally should have very little impact on its market price and capital value.

If the coupon rate is fixed, the fixed yield on the bond may force the bond’s market price to change to keep pace with changing interest rates. So, if interest rates rise, the bond’s market value generally falls. If you sell a bond under this scenario prior to maturity, you could experience a capital loss.

Credit risk is the risk that the investor will not receive all the interest and principal on time. Generally, the higher the credit quality of the issuer, the lower the risk associated with the bond and therefore the lower the interest rate required by investors.

For this reason, government bonds typically pay a lower interest rate than corporate bonds because the credit risk is lower. Similarly, secured corporate bonds typically pay a lower interest rate than unsecured corporate bonds because the credit risk is lower. However, this does not mean that your investment is risk-free.

Liquidity risk is the risk of not being able to sell your bond quickly and easily in the market if you need to. For some corporate bonds, particularly those with small amounts on issue, liquidity may be poor.

In contrast, government bonds are highly liquid, being traded not only on ASX but also actively in the wholesale market. For some bonds (like Exchange-traded Australian Government Bonds), ASX has dedicated market makers whose job is to ensure that there is always a fair price for you to trade with.

 

Research and helpful information