Investment bonds

If you are already familiar with bonds, then you know that the hallmark of bonds is fixed income – when you buy a bond, you know how much interest the company that issued the security must pay you.

However, there are also such bonds in which the interest rate is not known in advance, but is determined depending on certain conditions. Due to the fact that the interest rate is not fixed, the potential yield of such a bond can significantly exceed the yield on fixed income bonds and similar instruments.

Let’s look at the example of investment bonds.

An investment bond is a debt security. When an investor buys it, he is actually lending to the issuer of the security. Investment bonds have a specific maturity – usually from six months to five years. Thus, as with ordinary bonds, on the maturity date, the bank undertakes to return the bond’s par value, i.e. the capital that the investor has invested in these bonds. A feature of this product is the mechanism for calculating income – how many percent in addition to the face value the investor will receive. Unlike regular bonds, product yield depends on the dynamics of other financial instruments such as stocks, bonds, commodities, rates, etc. Such instruments are called the underlying assets of an investment bond. Let’s see how exactly income is determined and how it depends on these underlying assets.

Investment bond income has two components:

1. Fixed income, usually set at 0.01% per annum.
2. Income, which depends on the dynamics of the underlying assets.

The terms of payment of the second part of income depend on the type of investment bond.

MAIN TYPES OF INVESTMENT BONDS:

1. Participation in the dynamics of the underlying asset. An investment bond provides the investor with income based on the rise or fall of the underlying asset. The investor’s participation in changing the price of the underlying asset can be more or less than 100% (participation rate), i.e. if the asset grows by 1%, then the investor’s income may increase by more or less than 1% – depending on the participation ratio. This yield in such bonds is usually paid at the end of the maturity. The product is suitable for investors who want to invest in the growth of an asset but are not ready to risk the invested funds.

Example: an investment bond for participation in the growth of the Moscow Exchange index with a participation ratio of 110%. If at the time of bond maturity, the index shows a positive trend, the investor will be paid an income equal to the value of the growth of the exchange index multiplied by the participation coefficient. If the index rises by 10% with a participation rate of 110% (or 1.1), then the return will be 10% * 1.1 = 11%.

2. Accumulation corridor. An investment bond provides the investor with income for each day the asset is in a predetermined range. The bond usually pays the accrued collateral income on a regular basis. The product is suitable for investors who are not sure about the growth or fall of the market, as it allows them to earn increased income even during periods of calm in the market.

Example: An investment bond pays a return of 9% per annum for each day that gold is in the +/- 150 USD range from the price it was posted. If the gold price on the day of placement was $ 1,650, then the range would be $ 1,500-1,800. If the price of gold has not gone beyond the corridor even once in a year, the investor receives 9%.

3. Bonds with “memory effect” of the coupon. An investment bond provides the investor with income if the underlying asset is above a certain barrier – this is a “payout condition”. Often the underlying asset in such bonds is a basket of stocks, and the payout condition is observed for the worst stock in the basket. A special feature of the bond is the “memory effect” of the coupon – if the condition for payment of income has not been met, then the income does not disappear and can be paid on one of the following dates of payment of income, provided that the payment condition on that date is met. If the payment condition is met, then the additional income is regular. The product is suitable for investors who want to participate in the growth of the market, but for whom it is important to receive a regular income.

Example: an investment bond pays a yield of 4.5% once every six months if 4 shares are at least 92% (drawdown up to 8%) of their prices on the date of the bond placement. If on the first coupon date the price of at least one share from the basket has decreased by more than 8%, then the coupon is not paid, but is “remembered”. This means that if on any of the following coupon dates all 4 shares are above the 92% level, then all missed coupons are paid out.

As you can see from these examples, the yield on an investment bond can be higher than on a regular bond.

ADVANTAGES FOR THE INVESTOR:

1. Reliability – the issuer undertakes to redeem the bond at par, that is, the investor does not risk capital (early sale in the secondary market can be either higher or lower than the purchase price).
2. Potential yields may exceed deposit rates, inflation and yields on high credit quality bonds of similar maturity.
3. Liquidity – bonds can be sold on the secondary market on any day of circulation.

Thus, investment bonds allow you to try to invest in the market without risking the invested capital.