Bonds: Characteristics, Issuers, and Investment Insights
CISI – Financial Products, Markets & Services
Topic – Bonds
(5.1.1 and 5.2.1)Characteristics and Government Bonds
What are bonds?
With bonds, investors typically lend money to the
company in return for:
1.
The promise to have the
loan repaid on a fixed
future date
and
2.
To receive
a series of interest payments
A bond is, very simply, a loan that is represented
by an IOU (I owe you).
If a company wants to borrow some money to
enable it to expand, it could:
a)
Borrow it from
a bank
, or
b)
Issue
bonds
instead.
Issuers of bonds
Purpose of issuing bonds:
1.
Finance
spending and investment
2.
Bridge the
gap between their actual spending
and their income
they receive (taxes and other
receipts)
When
tax revenues
are
a lot less
than
government
spending
– issuance of government bonds are
high
Major issuers:
Western governments
e.g. UK, USA, Germany and
France - the volume of government bonds in issue is
very large.
Bonds form a
major part of the investment portfolio
of many institutional investors
(such as pension funds
and insurance companies).
Purpose of issuing bonds:
1.
Fund
expansion and
finance
investment
2.
Generally
cheaper and fewer restrictions
compared with borrowing from a financial
institution
3.
Issuing bonds does
not effect ownership
Major issuers:
Most of the corporate bonds are issued by listed
companies, such as the
large bank
s and other
large corporate organisations
like McDonald’s.
The term
corporate bond
is usually
restricted
to longer-term debt instruments
, with a
redemption date that is
more than one year
away at the point of issue
.
Characteristics of bonds
Bonds are also known as:
Loan stock
Debt instruments
Fixed interest securities
Bonds are
tradeable instruments
:
The investor in a bond
could sell
that
bond onto another investor
without the
need to refer to the original borrower
Terminology
ABC plc will pay:
£10,000
6 year
7%
Issuer
– in this case ABC plc is a
company promising to repay the
amount
Nominal/Face Value/Par value or
principal
– This is the
original value
of the
bond - what the original investor paid for
it and the
amount on which the interest is
calculated
Maturity or Redemption date
– The date
at which the bond matures and the
nominal value is paid back to the owner
Coupon–
The annual rate of interest
paid to the owner, based on the nominal
(face value)
Characteristics of bonds – Tradeable
Remember that bonds can be
sold on to somebody else
– this can be done
without the knowledge of the original borrower.
They are
tradeable financial
instruments.
What does this mean?
A bond
will not always trade
at its
nominal value
For example.......
Original investor
pays £10,000 for the
bond (nominal) with
a coupon of 7%
Looks to sell
the bond
after 2-years
BUT
The 7% coupon
rate may no
longer be
competitive
Interest rates
have gone
up in the 2-
year period
New buyer
reviews the
situation
New buyer
will only pay
£9,500 for the bond. They
keep the bond until
maturity when they receive
the £10,000 nominal back.
The £500 difference is the
compensation for the
uncompetitive 7% coupon
Government bonds
UK government bonds are known as
gilts
.
This dates back to the days when the physical certificates
were
issued with a real gold
or ‘gilt’ edges to them
, so they
became known as ‘gilts’ or ‘gilt-edged stock’.
Bonds are issued on behalf of the UK government by the
Debt Management Office (DMO).
The total amount of
new gilts issued is
called the
‘gross’
amount and the
total amount
less
redemptions
is the
‘net’
amount.
The chart also
shows the
percentage of
GDP represented
by the total of gilts
in issue.
Characteristics of a typical UK Government bond
5 PER CENT TREASURY STOCK, 2025
£10,000 ***
Repayable at par on 7 December 2025
Interest payable half-yearly on 7 June and 7 December
Price £101.25
Stock
UK Government
bonds are
named by their
coupon rate
and their
redemption
date
Redemption date
The year in which the
stock will be repaid
. Repayment will take
place at the
same time as the final interest payment
is made. The
amount repaid will be the
nominal amount
of stock held; that is,
£10,000
Value £10,125.00
Coupon
The annual rate of interest is
quoted gross
(before the
deduction of any tax that might
be payable) and for UK
government bonds it is normally
paid in
two separate and equal
half-yearly interest payments
made 6 months apart
Price
the convention in
the bond markets
is to
quote prices
per £100 nominal
of stock. So, in this
example, the
price is £101.25 for
each £100
nominal of stock.
Value
nominal amount of
stock x current price.
Nominal
The amount of stock
purchased -
not necessarily
the same as the amount
invested or the cost of
purchase
. This is the amount
on which interest will be paid
and the amount that will
eventually be repaid.
Types of government bonds:
Conventional bonds
2028
6%
Treasury stock
Carry a
FIXED
coupon
Has a
SINGLE
repayment
date
It is conventional bonds that represent the
majority of government
bonds in issue
.
Types of government bonds:
Index-linked bonds
2020
2%
Index-linked stock
Specified
coupon
Specified
redemption date
BUT
Both the
coupon
and the
redemption amount (Nominal)
are increased
(uplifted) by the amount of
inflation
.
Coupon
uplift calculated
between the interest payment date and the bond issue date
Nominal
uplift adjusted upwards to reflect inflation
between the bond’s issue date and
redemption date.
Who do they appeal to?
Investors worried about inflation
- provides
extra protection
when inflation is uncertain
Long-term investors such as pension f
unds - like to know that the returns will maintain
their real value after inflation so that
they can meet their ob
ligations to pay pensions.
Types of government bonds:
Dual-dated bonds
2028-2032
6%
Treasury loan
Carry a
FIXED
coupon
Has
TWO DATES BETWEEN
which
repayment can be made
The decision as to when to repay will be
made by the government
and will
depend on the prevailing rates of interest
at that time.
What is the advantage?
It gives more flexibility for a government but can be unpopular with investors -
in the case above, the government had the option of repaying the bond
within the four-year period. If....
In 2028,
interest rates
fall to below
6%
The government
repays
the 6%
Treasury stock
2028-2032
The government
issues
new bonds
at a
lower
coupon rate
, saving them
money in interest
payments
Types of government bonds:
Irredeemable/Undated bonds
3%
War loan
Carry a
FIXED
coupon
Has
NO
repayment date
Also known as
perpetual
or
undated stocks
Issued to help government expenditure in World War I
Investor appeal or lack of .......
a)
Lack of a certain repayment date is unattractive to investors.
b)
The government does repay a small amount of its undated stock each year
using a mechanism called a sinking fund
c)
Investors can be selected by ballot and their undated stock will be repaid
at nominal value.
Gilt Strips
‘Stripping’ a gilt refers to
breaking it down into its individual cash flows
which
can be traded separately as zero-coupon gilts.
As seen above, a three-year gilt will have seven individual cash flows: six
(semi-annual) coupon payments and the final maturity repayment.
STRIP
stands for
Separate Trading of Registered Interest and Principal.
Bonds are financial instruments representing loans, allowing companies and governments to raise funds. This article explores the characteristics of bonds, including tradeability, issuer profiles, terms like face value and coupon rate, and the importance of bonds in investment portfolios.
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Presentation Transcript
CISI Financial Products, Markets & Services Topic Bonds (5.1.1 and 5.2.1)Characteristics and Government Bonds cisi.org
What are bonds? A bond is, very simply, a loan that is represented by an IOU (I owe you). If a company wants to borrow some money to enable it to expand, it could: a) b) Borrow it from a bank, or Issue bonds instead. With bonds, investors typically lend money to the company in return for: 1. The promise to have the loan repaid on a fixed future date and 2. To receive a series of interest payments cisi.org
Issuers of bonds Listed Companies Purpose of issuing bonds: Governments Purpose of issuing bonds: 1. Fund expansion and finance investment 1. Finance spending and investment 2. Generally cheaper and fewer restrictions compared with borrowing from a financial institution 2. Bridge the gap between their actual spending and their income they receive (taxes and other receipts) 3. Issuing bonds does not effect ownership When tax revenues are a lot less than government spending issuance of government bonds are high Major issuers: Major issuers: Most of the corporate bonds are issued by listed companies, such as the large banks and other large corporate organisations like McDonald s. Western governments e.g. UK, USA, Germany and France - the volume of government bonds in issue is very large. The term corporate bond is usually restricted to longer-term debt instruments, with a redemption date that is more than one year away at the point of issue. Bonds form a major part of the investment portfolio of many institutional investors (such as pension funds and insurance companies). cisi.org
Characteristics of bonds Bonds are also known as: Bonds are tradeable instruments: Loan stock Debt instruments Fixed interest securities The investor in a bond could sell that bond onto another investor without the need to refer to the original borrower Issuer in this case ABC plc is a company promising to repay the amount Terminology ABC plc will pay: Nominal/Face Value/Par value or principal This is the original value of the bond - what the original investor paid for it and the amount on which the interest is calculated 10,000 6 year Maturity or Redemption date The date at which the bond matures and the nominal value is paid back to the owner 7% Coupon The annual rate of interest paid to the owner, based on the nominal (face value) cisi.org
Characteristics of bonds Tradeable Remember that bonds can be sold on to somebody else this can be done without the knowledge of the original borrower. They are tradeable financial instruments. What does this mean? A bond will not always trade at its nominal value For example....... BUT Looks to sell the bond after 2-years New buyer reviews the situation New buyer will only pay 9,500 for the bond. They keep the bond until maturity when they receive the 10,000 nominal back. The 500 difference is the compensation for the uncompetitive 7% coupon Interest rates have gone up in the 2- year period The 7% coupon rate may no longer be competitive Original investor pays 10,000 for the bond (nominal) with a coupon of 7% cisi.org
Government bonds UK government bonds are known as gilts. This dates back to the days when the physical certificates were issued with a real goldor gilt edges to them, so they became known as gilts or gilt-edged stock . Bonds are issued on behalf of the UK government by the Debt Management Office (DMO). The total amount of new gilts issued is called the gross amount and the total amount less redemptions is the net amount. The chart also shows the percentage of GDP represented by the total of gilts in issue. cisi.org
Characteristics of a typical UK Government bond Redemption date The year in which the stock will be repaid. Repayment will take place at the same time as the final interest payment is made. The amount repaid will be the nominal amount of stock held; that is, 10,000 Stock UK Government bonds are named by their coupon rate and their redemption date 5 PER CENT TREASURY STOCK, 2025 Price the convention in the bond markets is to quote prices per 100 nominal of stock. So, in this example, the price is 101.25 for each 100 nominal of stock. Repayable at par on 7 December 2025 Interest payable half-yearly on 7 June and 7 December Price 101.25 Value 10,125.00 10,000 *** Coupon Nominal Value The annual rate of interest is quoted gross (before the deduction of any tax that might be payable) and for UK government bonds it is normally paid in two separate and equal half-yearly interest payments made 6 months apart The amount of stock purchased - not necessarily the same as the amount invested or the cost of purchase. This is the amount on which interest will be paid and the amount that will eventually be repaid. nominal amount of stock x current price. cisi.org
Types of government bonds: Conventional bonds 6% Treasury stock 2028 Has a SINGLE repayment date Carry a FIXED coupon It is conventional bonds that represent the majority of government bonds in issue. cisi.org
Types of government bonds: Index-linked bonds 2% Index-linked stock 2020 Specified redemption date Specified coupon BUT Both the coupon and the redemption amount (Nominal) are increased (uplifted) by the amount of inflation. Coupon uplift calculated between the interest payment date and the bond issue date Nominal uplift adjusted upwards to reflect inflation between the bond s issue date and redemption date. Who do they appeal to? Investors worried about inflation - provides extra protection when inflation is uncertain Long-term investors such as pension funds - like to know that the returns will maintain their real value after inflation so that they can meet their obligations to pay pensions. cisi.org
Types of government bonds: Dual-dated bonds 6% Treasury loan 2028-2032 Carry a FIXED coupon Has TWO DATES BETWEEN which repayment can be made The decision as to when to repay will be made by the government and will depend on the prevailing rates of interest at that time. What is the advantage? It gives more flexibility for a government but can be unpopular with investors - in the case above, the government had the option of repaying the bond within the four-year period. If.... In 2028, interest rates fall to below 6% The government repays the 6% Treasury stock 2028-2032 The government issues new bonds at a lower coupon rate, saving them money in interest payments cisi.org
Types of government bonds: Irredeemable/Undated bonds 3% War loan Has NO Carry a FIXED coupon repayment date Also known as perpetual or undated stocks Issued to help government expenditure in World War I Investor appeal or lack of ....... a) Lack of a certain repayment date is unattractive to investors. b) The government does repay a small amount of its undated stock each year using a mechanism called a sinking fund c) Investors can be selected by ballot and their undated stock will be repaid at nominal value. cisi.org
Gilt Strips STRIP stands for Separate Trading of Registered Interest and Principal. 6% Treasury stock 2018 Maturity 07.06.18 Coupon 1 07.06.15 Coupon 2 07.12.15 Coupon 3 07.06.16 Coupon 4 07.12.16 Coupon 5 07.06.17 Coupon 6 07.12.17 Nominal repaid 3% 3% 3% 3% 3% 3% Stripping a gilt refers to breaking it down into its individual cash flows which can be traded separately as zero-coupon gilts. As seen above, a three-year gilt will have seven individual cash flows: six (semi-annual) coupon payments and the final maturity repayment. cisi.org
