Bonds – a history
I thought I would talk this week about Government Bonds, their history and where they can fit into our financial plans. When asked about bonds I’m sure the majority of people would not know a lot about them or would think that they are only used by Governments to raise money for specific purposes, for example, Govt.War Bonds that appeared during both World Wars. The history of bonds shows that corporations have increasingly used the bond market to fund expansion and investment.
The history of bonds can be grouped into three specific periods.
1. Up to 1950 – the bond market was large and comprised mostly of publicly owned issuers – governments.
2. 1950-1980s – transition period from publicly owned to private issuers. During this period the financial sector was heavily regulated.
3. Late 80s to today – a period of strong growth in the bond market and increase in private issuers.
Since the early 20th century, Australian corporate bonds issues has grown at a rate of 4% annually. At around $825 billion (2012), the face value of outstanding bonds is around two-thirds of the market capitalisation of ASX listed equities and equivalent to 62% of gross domestic product (GDP). As you can see bonds have an integral influence on the whole of our economy. As a funding source, they are very important and we can invest in bonds as part of our own financial plan. *
*Research Discussion Paper – A History of Australian Corporate Bonds by Susan Black, Joshua Kirkwood, Alan Rai and Thomas Williams RDP 2012-09
What are government bonds?
In Australia, the Commonwealth issues bonds called Commonwealth Government securities. These are the most common bonds traded by individuals and can be freely bought and sold on the Australian Stock Exchange. You have to own a current stock broking account to be able to trade in bonds but once set up the transactions are quite quick and simple to do. The bonds will pay interest quarterly or half yearly at a fixed rate and the underlying face value varies according to the market. Investors can rely on a predictable cash flow that is paid periodically and the bonds have a specified maturity date. You can equate bonds being similar to a fixed term deposit at bank which has periodic interest payments and repayment of principle at expiry. The main difference though is that bonds are able to be freely traded on the ASX at any time. If you try to cash in a term deposit before the expiry date you will be charged penalties.
What are the main benefits of bonds?
- As I have mentioned above bonds are easily traded on the ASX.
- Low risk – the face value of the bond will always be returned to you if held to maturity.
- Regular interest payments – Once you buy a bond the interest payments will arrive at regular intervals (usually quarterly of half yearly)
The problems with bonds –
There is only one problem with bonds and that is wanting to cash a bond in before it’s maturity date. If you do this you are open to the vagaries of the market and the economy at the time (what interest rates are doing). If you sell a bond it is only valued at the price someone is prepared to pay at that moment.
Bonds are a great way to put money aside that you don’t need for a while and they will also pay you income for the allocated time.
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