A bond is a security that pays a specific amount of interest for a given period of time and repays the face value of the security on the maturity date.
Bonds may improve portfolio diversification and help reduce portfolio risk while providing more stable income.
Government and companies issue bonds. Here’s what you need to know about government bonds.
What are they?
Government bonds are medium to long-term debt securities issued by the Australian Government, or state governments.
There are two types of Australian Government Bonds (AGBs) which trade on the Australian Stock Exchange:
- Exchange-traded Treasury Bonds (TBs): debt securities with a fixed face value. They carry the same annual rate of interest over the life of the security, payable every six months.
- Exchange-traded Treasury Indexed Bonds (TIBs): debt securities that hedge against inflation. Their face value is adjusted for movements in the Consumer Price Index (CPI). Coupon interest payments are paid quarterly at a fixed rate, on the CPI-adjusted capital value. At maturity, investors receive the face value of the security adjusted for CPI movement over the life of the bond.
The face value of one TB equals $100 and the face value of one TIB equals $100 plus CPI adjustment. The minimum parcel size is one AGB traded at the price quoted, with the usual parcel size between $30,000 and $50,000. TIBs typically trade in large parcels, putting them beyond the reach of many retail investors.
- AGBs have the lowest possible credit risk and they provide absolute security when held to maturity.
- You buy or sell them on the ASX the same way you buy or sell shares.
- There is typically a high level of stock availability and liquidity.
- Unlike other interest earning investments, your money is not locked away for the term of the investment.
- AGBs can help diversify your portfolio, offsetting the risk of other investments like shares or property.
- Regular coupon interest payments provide a secure, stable and reliable cash flow.
- Generally if interest rates decrease the price of a TIB is likely to rise.
- Yields will generally be lower than most other (higher risk) interest rate investments.
- AGB prices will fluctuate. The Australian Government does not guarantee investment performance and will not compensate investors for investment losses.
- If you purchase TIBs for a price greater than the nominal value, sell the TIBs prior to their maturity date or there is a decline in the CPI, you could incur capital losses (note there is a floor on coupon interest payments which may protect TIB holders in an environment of deflation).
- Generally if interest rates increase, the price of a TIB is likely to fall.
- The Australian Government may, with three months notice, convert holdings of TIBs to the underlying Treasury Indexed Bonds directly registered in the Commonwealth Stock Registry. Investors would continue to receive the same interest payments and maturity amounts they were entitled to, but would not be able to sell their TIB investments on the ASX, rather through bond traders who deal in bigger parcels.