What are debt instruments and why should investors know about them in 2024?

In the world of investing, if you’re tired of the market volatility but still don’t want to keep your money in a bank account with low interest rates, the answer lies in bonds. This asset is viewed as a middle ground that offers reasonable returns while keeping risks at a manageable level.

What Are Bonds? Keep It Simple

Imagine bonds as a contract between you (lender) and a company or government (borrower). When you purchase a bond, you become a creditor with the right to receive interest over time and expect to get your principal back at maturity. The issuer is responsible for paying interest regularly and returning the principal as agreed.

Here’s the appeal of bonds: they offer higher returns than regular savings accounts, but the risks remain significantly lower than investing in stocks.

5 Main Risks Investors Need to Know

However, investing in bonds isn’t risk-free. It’s important to understand the various associated risks:

Default Risk – If the issuer faces financial difficulties, they may fail to pay interest or principal in full. It’s crucial to assess the financial health of the bond issuer carefully.

Interest Rate Risk – When central banks raise interest rates, bonds with lower fixed rates become less attractive. You might need to sell such bonds at a discount to reinvest in higher-yielding ones.

Liquidity Risk – Bonds don’t have a market as active as stocks. If you want to sell before maturity, finding a buyer may be difficult, and you might have to accept a lower price.

Inflation Risk – If inflation exceeds your bond’s interest rate, your purchasing power diminishes. For example, earning 3% interest in an environment with 5% inflation doesn’t mean you’re making a profit.

Reinvestment Risk – When bonds mature, the market might not offer equally attractive investment options to reinvest your principal.

Hidden Rights to Watch Out For

Besides returns and inherent risks, some bonds come with “embedded options” that can alter your returns:

Call Option – The issuer can redeem the principal early. If this happens when interest rates are lower, you’ll need to reinvest at lower rates.

Put Option – Conversely, you may have the right to sell the bond back to the issuer before maturity, which can be advantageous if the issuer faces problems.

Conversion Option – Some bonds allow conversion into shares of the issuing company. If the stock performs well, you benefit; but there’s also stock market risk.

How Many Types of Bonds Are There?

The bonds available in the market today are diverse but can be categorized based on certain criteria:

By Issuer

• Government Bonds – Backed by the government, low risk but lower interest rates, suitable for safety-focused investors.

• Government Agency Bonds – Not fully guaranteed but still relatively low risk as they are contractual obligations of the state.

• Corporate Bonds (debentures) – Risk varies depending on the company’s stability. Companies seeking more funds typically offer higher interest rates to attract investors.

By Claim Priority

• Subordinated Bonds – In case of bankruptcy, these are paid after other creditors, thus higher risk.

• Senior Bonds – Paid before other creditors, lower risk.

By Collateral

• Secured Bonds – Backed by assets of the company, lower risk.

• Unsecured Bonds – Rely solely on the issuer’s creditworthiness.

By Interest Payment Method

• Regular Coupon Bonds – Receive fixed interest payments periodically, usually twice a year, suitable for cash flow needs.

• Zero-Coupon Bonds – No periodic interest; purchased at a discount and redeemed at face value at maturity.

• Non-Interest Bonds – Sold below face value with returns derived from price difference.

By Interest Rate Type

• Fixed Rate – Interest remains unchanged, making income planning easier.

• Floating Rate – Interest varies with market rates; when rates rise, returns increase accordingly.

How to Calculate Returns

Suppose you buy a bond with a face value of 10,000 THB, an 8% annual coupon rate, paid semi-annually, for 4 years.

Interest per payment: 10,000 × (0.08/2) = 400 THB

Two payments per year = 800 THB annually

Over 4 years = 3,200 THB in interest

Plus, you get back the principal at maturity: 10,000 THB

Total amount received at maturity: 13,200 THB

Your profit from this bond investment is 3,200 THB.

How to Buy and Sell Bonds

Primary Market (Primary Market)

Bonds are purchased directly from the issuer or through financial institutions. During the initial offering, details such as interest rate, amount, maturity, and conditions are specified. Investors should review these terms carefully to determine if they align with their investment plans.

Secondary Market (Secondary Market)

After purchasing bonds, if you wish to sell, you can do so via the secondary market, also known as Over The Counter (OTC) (OTC). In Thailand, this is called BEX (Bond Electronic Exchange). Investors contact securities firms to execute trades. Settlement occurs within T+2 days, and bonds are stored at the Thailand Securities Depository (TSD) (TSD). This process makes buying and selling more convenient and secure than direct transactions.

Is Investing in Bonds in 2024 a Good Idea?

Bonds are considered a favorable option at this time for several reasons:

Flexible Investment Periods – Ranging from 1 day to 20 years, allowing you to choose according to your plan.

Steady Cash Flow – Regular interest payments provide consistent income, supporting your regular financial needs.

Better Returns than Bank Deposits – Banks offer low interest rates; bonds issued by companies or governments typically offer higher yields to attract investors.

Lower Risk than Stocks – Bondholders have priority over shareholders in claims, making them safer.

Moderate Liquidity – Besides primary market transactions, the secondary market allows for buying and selling.

Bonds vs. Stocks: How to Invest?

When comparing these two options, the main differences are:

Returns – Stocks have the potential for higher returns, especially from capital appreciation and dividends, but bonds offer fixed, more conservative yields.

Risks – Stocks are highly volatile, sometimes up to three times more than bonds. Bonds tend to maintain their value and returns more consistently during both boom and crisis periods.

Analysis Approach – Stock selection requires analyzing profitability, industry, competition, and intrinsic value, which is more complex. Bond selection involves assessing the issuer’s creditworthiness, understanding interest rates, and contractual terms.

Recommendations:

• If you’re young and willing to take risks for higher gains – Choose stocks, as you have time to recover losses.

• If you’re nearing retirement or financial independence – Bonds may be better, providing steady returns and peace of mind.

• If you want a balanced portfolio – Combining stocks and bonds is a prudent approach. When stock markets decline, bonds can still generate steady returns, reducing overall losses.

Summary

Bonds are a relatively attractive investment tool in 2024, especially for those seeking to avoid the risks of stock markets but still aiming for better returns than savings accounts. By understanding the types, risks, and investment methods of bonds, you can make more confident decisions. Remember, no investment is without risk; the key is to choose options that align with your personal situation and goals.