For Finance (Basics)
On the topic:
Bonds. Online trading.
BONDS. ONLINE TRADING.
First of all it is necessary to give an explanation to what Bonds are. Bond is an official paper given by the government or a company to show that you have lent them money that they will pay back to you at an interest rate that does not change1. In other words, a bond is a formal contract to repay borrowed money with interest at fixed intervals. The main entities that issue bonds are public authorities, credit institutions, companies and supranational institutions in the primary markets.
It is necessary to cover the most important features of a bond, that are the following:
nominal, principal or face amount — the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate or a fund. This can result in an investor receiving less or more than his original investment at maturity.
issue price — the price at which investors buy the bonds when they are first issued, which will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees.
maturity date — the date on which the issuer has to repay the nominal amount. As long as all payments have been made, the issuer has no more obligation to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term of up to thirty years. Some bonds have been issued with maturities of up to one hundred years, and some do not mature at all. In the market for U.S. Treasury securities, there are three groups of bond maturities:
short term (bills): maturities between one to five year; (instruments with maturities less than one year are called Money Market Instruments)
medium term (notes): maturities between six to twelve years;
long term (bonds): maturities greater than twelve years.
coupon — the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.2
The "quality" of the issue refers to the probability that the bondholders will receive the amounts promised at the due dates. This will depend on a wide range of factors.
Indentures and Covenants — an indenture is a formal debt agreement that establishes the terms of a bond issue, while covenants are the clauses of such an agreement. Covenants specify the rights of bondholders and the duties of issuers, such as actions that the issuer is obligated to perform or is prohibited from performing. In the U.S., federal and state securities and commercial laws apply to the enforcement of these agreements, which are construed by courts as contracts between issuers and bondholders. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or super-majority) vote of the bondholders.
High yield bonds are bonds that are rated below investment grade by the credit rating agencies. As these bonds are more risky than investment grade bonds, investors expect to earn a higher yield. These bonds are also called junk bonds.
Coupon dates — the dates on which the issuer pays the coupon to the bond holders. In the U.S. and also in the U.K. and Europe, most bonds are semi-annual, which means that they pay a coupon every six months.
Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like features to the holder or the issuer:
Callability — some bonds give the issuer the right to repay the bond before the maturity date on the call dates. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
Putability — some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates. These are referred to as retractable or putable bonds.
call dates and put dates—the dates on which callable and putable bonds can be redeemed early. There are four main categories.
A Bermudan callable has several call dates, usually coinciding with coupon dates.
A European callable has only one call date. This is a special case of a Bermudan callable.
An American callable can be called at any time until the maturity date.
A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in the event of the beneficiary's death or legal incapacitation. Also known as a "survivor's option".
sinking fund provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.
convertible bond lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
exchangeable bond allows for exchange to shares of a corporation other than the issuer.
There are a plenty amount of different types of bonds, existing nowadays. Actually, the bond market offers investors a lot more choices than the stock market. Which bonds to choose depends on the goals, tax situation and the risk tolerance of a person who is going to invest in bonds. The broad bond market includes in itself government, municipal, corporate, mortgage-backed or asset-backed securities and international bonds. Within each broad bond market sector it is possible to find securities with different issuers, credit ratings, coupon rates, maturities, yields and other features. Each one offers its own balance of risk and reward. In more details:
Government Bonds - fixed-income securities are classified according to the length of time before maturity. These are the three main categories:
Bills - debt securities maturing in less than one year.
Notes - debt securities maturing in one to 10 years.
Bonds - debt securities maturing in more than 10 years.
For example, marketable securities from the U.S. government - known collectively as Treasuries - follow this guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills). Technically speaking, T-bills aren't bonds because of their short maturity. All debt issued by Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many developing countries, however, does carry substantial risk. Like companies, countries can default on payments.
Municipal bonds, known as “munis”, are the next progression in terms of risk. Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities, which use the money to build schools, highways, hospitals, sewer systems, and many other projects for the public good.
Corporate bonds (also called corporates) are debt obligations, or IOUs, issued by private and public corporations. They are typically issued in multiples of $1,000 and/or $5,000. Companies use the funds they raise from selling bonds for a variety of purposes, from building facilities to purchasing equipment to expanding their business.
Zero - Coupon Bonds.
Zero-coupon bonds pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating ("stripping off") the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately.
International bonds include Eurobonds, foreign bonds and global bonds. A different type of international bond is the Brady bond, which is issued in U.S. currency. Brady bonds are issued in order to help developing countries better manage their international debt. International bonds are also private corporate bonds issued by companies in foreign countries, and many mutual funds in the United States hold these bonds.
As everything has its own pluses and minuses, so bonds also have their own advantages and disadvantages. To make a list short it is important to name just the main points. If we are talking about advantages of Bonds, we can say that Bonds give higher interest rates compared to short-term investments. Also Bonds are less risky compared to stocks. But disadvantages are the following: firstly, selling bonds before they’re due may result in a loss, a discount. And secondly, if the issuer of the bond declares bankruptcy, you may lose money.
Now, when it is clear about what Bonds are, we can go to the next point of this essay. Trading Bonds and trading them online.
So, the main question is – how a person can buy the Bonds? Most bond transactions can be completed through a full service or discount brokerage.
The full service broker is a broker that provides a large variety of services to its clients, including research and advice, retirement planning, tax tips, and much more. Of course, this all comes at a price, as commissions at full-service brokerages are much higher than those at discount brokers.
A discount broker is a stockbroker, who carries out buy and sell orders at a reduced commission compared to a full-service broker, but provides no investment advice.3
It used to be that only the wealthy could afford a broker and access to the stock market. The internet has brought an explosion of discount brokers which let you trade at a smaller fee. However, it is important to remember that discount brokers don't provide personalized advice. Because of discount brokers, nearly anybody can afford to invest in the market.
It is important to mention, that for those who wish to do their own research or don't want to invest a lot of money, a discount broker is an excellent way to invest.
It is also possible to open an account with a bond broker, but be warned that most bond brokers require a minimum initial deposit of $5,000. If this amount, for example is not affordable, it can be suggested to look at a mutual fund that specializes in bonds (or a bond fund).
Some financial institutions will provide their clients with the service of transacting government securities. However, if the clients bank doesn't provide this service and s/he do not have a brokerage account, s/he can purchase government bonds through a government agency (this is true in most countries). In the U.S. the person can buy bonds directly from the government through TreasuryDirect at http://www.treasurydirect.gov. The Bureau of the Public Debt started TreasuryDirect so that individuals could buy bonds directly from the Treasury, thereby bypassing a broker. All transactions and interest payments are done electronically.
If a person decides to purchase a bond through his broker, he or she may tell to the person that the trade is commission free. But actually it is not the true. What typically happens is that the broker will mark up the price slightly; this markup is really the same as a commission. To make sure that you are not being taken advantage of, simply look up the latest quote for the bond and determine whether the markup is acceptable.
Online trading of Bonds is very popular nowadays. Actually, online trading is the act of placing buy/sell orders for financial securities and/or currencies with the use of a brokerage's internet-based proprietary trading platforms. The use of online trading increased dramatically in the mid- to late-'90s with the introduction of affordable high-speed computers and internet connections.
The use of online trades has increased the number of discount brokerages because internet trading allows many brokers to further cut costs and part of the savings can be passed on to customers in the form of lower commissions.
Another benefit of online trading is the improvement in the speed of which transactions can be executed and settled, because there is no need for paper-based documents to be copied, filed and entered into an electronic format.
There is an abundance of information on the web about equities from latest news to historical charts and even to current stock quots. Sites such as Yahoo!, Excite or Stocksmart are just a few places that provide extensive market data for no charge at all.
There is scant bond information available. And also about investors. While investors have poured some $10.8 trillion into the U.S. equity markets, there has been substantially more money invested in bonds. Last year a total of $12.1 trillion was invested in bonds--Treasuries, corporates, municipals, federal agency bonds.
If to take a good look at the financial offerings on the web the findings can be mixed. There is scant bond information available and what is available is largely geared to institutional investors. For example, just eight sites available with any form of current or near-live U.S. bond data. But unlike the free information available to stock investors, the person has to pay a subscription rate ranging from $39.95 to $295 a month.4
If the person is only interested in learning about fixed income investing, there is plenty of good content. And there are some web-sites to visit for this information. The Bond Market Association (formerly the Public Securities Association)--basically a lobbying group for the bond industry--represents securities firms and banks that underwrite, trade and sell debt securities. A key advantage of the site is the links it offers to dozens of institutional sites providing data and content on the fixed markets.
The federal government and two private funding groups offer a number of sites: from the Ginnie Maes, Fannie Maes and Freddie Macs to the U.S. Treasuries. Each has its own unique web site, with educational material for investors as well as information about specific legislative and regulatory subjects.
It is also possible to find fixed income primers and helpful materials from many of the major mutual fund companies and investment houses like Vanguard and Merrill Lynch.
Most equity data available on the Internet is delayed by maybe 15 to 20 minutes. Sites that offer real-time quotes typically come with a monthly subscription cost. Or you can get live quots from Fox Television. It is also possible to get live data from online brokerage houses, but that is usually reserved for their customers.
By comparison, live fixed income data doesn't come as easily. GovPX is the single largest source of Treasury prices and yields. The outfit, formed some seven years ago, is owned by the 36 broker-dealers like Salomon Bros. and Merrill Lynch, and the half-dozen inter-dealer brokers like Garban Securities and Liberty Brokerage. GovPX collects all Treasury data on prices, yields, trade size and quantity and packages it for the broker dealers in an effort to provide transparency to the Treasury market.
GovPX is aimed primarily at institutional investors. However, since GovPX is the best source for Treasury bond data, other web sites, such as Dow Jones Markets' indepth.com, pay GovPX to use its data. They then add other more customized data and products for their own subscribers. For example, MoneyLine Corp., a firm that distributes live bond market data and news to the capital markets business, pays GovPX a fee for the right to post its data on their web site as MoneyLine tries to be its own one-stop outlet for bond information. While GovPX does provide live quots to those actively in the Treasury market, its own web site provides only end-of-day data at no charge.
Live fixed income data doesn't come easily. In addition, MoneyLine5 offers data on emerging market bonds, discount and bond calculators, up-to-the-minute market news headlines, even live bond offerings. All this will set a person back quite a bit--MoneyLine's fees begin at $100 a month. Once the person enters the site's Trading Room, s/he are transferred to a Windows Telnet environment where your mouse will not work. While the information is quite good, getting around the menu is initially cumbersome, and you have to use your keyboard for navigation.6 A Windows-based product is available since April.
Other sites that offer the GovPX data--either via link or fee arrangement--include Bondtrac7 and PC Trader. However, the Bondtrac site, which charges $99 a month, is limited to professional, licensed broker/dealers.
PC Trader is worth a visit but subscriptions aren't cheap, running at least $175 a month. The outfit offers all the screens a professional Wall Street trader would need. At first it is necessary to download its trading software before you can access the 24-hour, live quots and market news. For additional monthly charges, subscribers can access foreign exchange rates, futures and commodities.
A more user-friendly offering is by Cypress Mortgage Corp. Cypress provides everything a retail bond investor needs to know, including key benchmark figures, economic and news headlines and a host of content relating to the mortgage and credit markets. The pricing and yield data are updated hourly, which is probably sufficient for most investors. There is no charge to access the site.
Despite the general lack of fixed income, there are two sites where investors can trade bonds online. They belong to Fidelity Investments8 and Charles Schwab9.
Fidelity offers brokerage clients online trading for all major fixed income products, including a daily state-by-state schedule of municipal bonds and recent offerings. For Treasuries, Fidelity charges $50 for orders of 20 bonds or less and nothing for orders with more than 20 bonds traded. For corporate bonds, which are traded through Fidelity's affiliate National Financial Services Corp., the rate is $36 plus $4 per bond for the first 25 bonds traded and $3 per bond from the 26th onwards.
How can be explained the dearth of fixed income information on the Internet? Schwab clients can trade all NYSE-listed corporate and convertible bonds and all Treasuries, at auction and in the secondary market. The cost to trade a corporate bond is $5 and there's a minimum charge of $31.10
How can be explained the dearth of fixed income information on the Internet? Blame it on the level of sophistication of individual investors. Stocks are generally easier to follow and to understand. There is not much discussion on chat rooms about the shape of the Treasury yield curve the way there is, for example, about Intel's latest chip introduction. The cost to access these fixed income sites is also quite prohibitive. Only the most active retail investors would be willing to pay on average $170 a month to get this live data on prices and yields.11
So as a conclusion it can be said that the best variant for small investors is to stick to mutual funds. Bond funds are ubiquitous and do away with the problems of building and then managing a bond portfolio.
Tim Gorman, How To Safely Trade Bonds So That You Actually Make Money
Bonds and bond derivatives, Miles Livingston, 1999