A bond in Australia is a formal document, such as a legal certificate or contract, representing money or goods loaned to another person. Bonds may be granted for business, personal finance and government borrowing. In some countries, they are also used when someone is released from prison; they must carry out specific tasks to pay off the debt before release.
Bonds issued by companies are a means of borrowing money from many people rather than just one financier. These bonds can be either secured or unsecured. A secured bond ensures repayment of the loan if an issuer defaults on its obligation – often called going bankrupt or going into liquidation. In contrast, an unsecured bond does not have this advantage. Instead, its repayment is predicated on the issuer’s ability to repay it.
Bonds became an essential source of funds for the development of Australia in the 1800s. For this reason, they are also known as ‘colonial bonds’ or just ‘colonial’. Nowadays, they continue to be issued by both federal and state governments (government bonds), companies (corporate bonds) and government-sponsored entities like local councils (municipal bonds). Bonds are usually denominated in Australian dollars but may also be in foreign currencies such as US dollars, British pounds or Euros.
Government Bonds
The Commonwealth Government of Australia is one of the most frequent issuers of debt instruments in Australia. The Commonwealth issues several different types of debt securities.
State and territory governments also issue bonds more frequently than before to raise money for big projects such as motorways, airports and public transport systems.
Corporate Bonds
Corporations may use bonds for several purposes, including financing their operations, acquiring other companies or corporations, or repaying existing debts. In some cases, using bonds can be cheaper than using shares. There are two primary varieties: secured and unsecured (also known as ‘debentures’). Unsecured corporate bonds are loans that do not offer specific security against default by an issuer. A secured bond is a loan in which the borrower pledges some asset as collateral for repayment. If the issuer defaults, the security holder can take possession of and sell it to recover part or all of their investment.
Individual Bonds
People who don’t want to invest in shares may purchase bonds directly from corporations using money they save over time. Bonds are often considered less risky than other investments but still produce regular and predictable income streams, contributing to their popularity with investors (known as creditors).
Bonds issued by Commonwealth Government entities such as Australia Post regularly become available on secondary markets such as online trading platforms. Well-established securities like these tend not to trade at significant premiums or discounts compared with their face value; however, new or less liquid bonds may trade at a discount to their face value.
Why invest in bonds?
- Bonds provide a regular and predictable income stream which is a good option for those who wish to supplement their primary source of income.
- Bonds have less volatility than shares, so they are suitable as part of a diversified investment portfolio.
- Bonds can be used as an effective way of holding money that isn’t needed immediately – such as saving up for a house deposit or education costs. Here’s some helpful advice on how to invest in bonds.
What are the Risks of Investing in Bonds?
Interest Rate Risk
The risk associated with interest rates is that bond prices move inversely with interest rates, and when interest rates rise, the price earned from maturity falls. To manage this risk, invest in bonds issued by different entities, have a range of terms to maturity and invest across sectors.
Market Price Volatility
The price that you buy and sell your bonds can fluctuate, causing losses to your investment. However, if you plan to hold them to maturity, this won’t affect the return you receive from that particular bond/investment.
Credit Risk
There is always a tiny chance that an issuer might default on their obligation. They no longer have enough money to repay you what they owe, but in many cases, the issuer can restructure or refinance their debt, so they still have funds available to repay investors.