Ways to make money on bonds, features of purchasing and choosing bonds

Investments

03.08.2020

14290

Author: Igor Smirnov

Photo: pixabay.com

Bonds are securities that give the right to receive income from the entity that issued them. Bonds may be resold on the secondary market.

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To explain what a bond is in simple words, you can do this:

• Bonds are receipts with an obligation to pay a certain amount on a specified date.
• The amount payable on bonds is greater than the amount spent to purchase them.
• Bonds can be resold, in this case the person obligated to pay does not change, but the recipient of the funds changes.

To better understand the place of bonds, you can compare them with shares of enterprises:

Photo: pixabay.com

Table of contents

1. What are bonds
2. Where and how to choose bonds
3. What bonds can you buy in the Russian Federation?
4. Bond yield
5. Where to open an account
6. How to choose a briefcase
7. Where to buy bonds
8. Taxes on profits from bonds
9. How to get a 13% tax deduction
10. Investment risks
11. Let's summarize: the pros and cons of investments

Coupon yield

As the accumulated coupon yield (ACY) increases, the value of the bond increases. After the coupon is paid, the cost is reduced by the amount of the NKD.

NKD

— accumulated coupon income
C
(coupon) — amount of coupon payments for the year, in rubles
t
(time) — number of days from the beginning of the coupon period

Example:

the investor bought a bond with a par value of 1000 rubles with a semi-annual coupon rate of 8% per year, which means a payment of 80 rubles per year, the transaction took place on the 90th day of the coupon period. His additional payment to the previous owner: NKD = 80 * 90 / 365 = 19.7 ₽

What are bonds

Bonds are fixed-income debt securities issued by commercial companies and government agencies.

The yield on bonds is quite often called a coupon - since bonds used to be in paper form (after the holder received a payment from the issuer, a paper coupon was torn off the bond). Currently, bonds operate electronically, but the term “coupon” is still actively used by market participants.

According to the form of payment, bonds are divided into:

1. interest (coupon) - issued at par value, the interest rate can be fixed or floating (floating is usually tied to the interbank rate - LIBOR, EURIBOR, etc.);
2. discount - such bonds are offered for purchase below their face value, with a certain discount;
3. amortizing bonds - these bonds pay some part of the principal debt and a coupon income on the balance.

As a rule, the income on bonds is known in advance and exceeds the income on bank details. Depending on the issuer, bonds can be state, municipal and corporate.

What are the nominal, current and dirty price of bonds?

The clearest definition is the par price of the bond. It is assigned by the issuer and does not change under any circumstances.

The market price of a bond, otherwise known as the bond quote, is the price at which the bond can be sold on the secondary market. On the one hand, you can calculate the resale price based on the nominal value, terms and income, on the other hand, this price is determined by supply and demand, and the buyer is not obliged to obey the calculations.

The “dirty price” is the market value of the bond at the time of sale, plus the already accrued coupon income. This is a fair reflection of the asset's true value.

How are bond yields calculated?

The correct calculation of bond yields is based on algebraic formulas with fractional values, percentages, roots and complex summation.

The simplest would be to calculate the “current percentage yield” (CY):

Current yield in % = (amount of coupon payments for the year / bond purchase price) * 100;

The “modified current yield” (MCY) is also considered:

MCY = amount of coupon payments for the year / “dirty price” * 100;

However, the price of a bond may change upon maturity or sale, i.e. they may give a nominal price for it, or they may add a premium or discount. Then the calculation becomes more complicated, although the indicator is called “simple yield to maturity”:

Simple yield to maturity = nominal price - market price + (yield on all future coupons - NKD) * 365 / number of days until bond maturity.

Complicating the calculations is the accrued coupon income (ACI) - an amount that has already been accrued but not yet paid, because the deadline has not yet arrived.

The NKD is added to the sale price of the bond.

The most objective and difficult to calculate indicator is usually called the “effective yield to maturity”.

or like this:

The result of the calculations, P is the fair “dirty” price of the bond at a given point in time.

To use these formulas, you need to remember your school algebra course and carefully check the data. It is easier, however, not to count on paper, but to use special programs - bond calculators.

What to look for when choosing bonds?

Bonds are a product in which many of the advantages and risks are clear in advance.

• The issuer of the bonds is known. This means there will be information about his economic situation.

There are special agencies that evaluate and assign ratings to bond issuers and the bonds themselves. There is also a threshold - a BBB- rating; bonds with a lower rating are considered unreliable.

• The interest rate on coupon bonds and the discount on discount bonds are immediately known. This way you can accurately determine the bond yield, overall and for the period.
• The liquidity of bonds is related to the rating and yield, i.e. the ability to quickly and expensively sell on the secondary market.
• An important parameter is the maturity date of the bonds. The closer the maturity date, the less you can earn from coupons or discounts. But bonds that mature after many years are less reliable because... During this time, the issuer's position may deteriorate.
• Many bonds require an offer. This is an option for early repayment at a nominal price. The offer can be “double-edged”; both the issuer and the bondholder can initiate the repayment.
• Compound interest may be applied to coupon bonds. When the amount of accumulated interest is used to purchase new bonds, which also generate income.

All this is known in advance and helps to correctly assess the benefits of specific bonds.

The coupon income assigned by the issuer for bonds is connected, although not strictly, with the rating and confidence in the issuer in the market. This can be clearly seen in government bonds of different countries:

The table shows several patterns at once:

• the better the economic position of the state and the confidence in it, the lower the coupon income it offers (but there is no direct dependence on specific indicators);
• coupon yield does not have a clear connection with real yield;
• some bonds have negative yields.

The same patterns can be seen in corporate bonds. But their profitability is usually higher, and this comes with greater risks.

A little about negative bond yields

Investing in bonds with negative yields seems absurd. But negative deposit rates recently seemed just as absurd. Essentially, banks now charge money for safe storage of funds, just like in the Middle Ages. However, you can still make money on bonds with negative yields.

To do this, you do not need to wait for their redemption, but you should carefully monitor their current price. These are papers with a high degree of reliability. Investors need them to stabilize high-yield, but less reliable securities in their portfolio. Bonds are purchased by central banks of states to reduce public debt, and by corporations to free themselves from unnecessary obligations. Demand leads to higher prices. Those who bought securities with negative yields cheaply make money.

However, it is not small investors with a passive strategy who usually benefit from bonds with negative income, but market professionals, incl. investment funds.

Where and how to choose bonds

When choosing a bond, you need to pay attention to the profitability, liquidity and creditworthiness of the issuer. A popular passive earning strategy is “Buy and Hold” - this strategy involves purchasing securities of highly reliable issuers with maximum profitability. Such securities include blue chips (companies with a growth trend) and second-tier securities characterized by moderate liquidity.

Bonds can be selected on such resources as:

• Rusbonds - on this site you can find a list of state, municipal and corporate bonds, as well as information about the terms and methods of repayment.
• Cbonds, a financial market data provider, has an intuitive interface and tools for comparing the returns of different securities.
• Ministry of Finance - on the website of the Ministry of Finance you will find reliable information about federal loan bonds (OFZ).

OFZ and corporate bonds

Information resources usually distinguish between government and corporate bonds. Government securities are considered extremely reliable and have regular coupon payments. The annual yield directly depends on the rate of the Central Bank of the Russian Federation.

Advice: Don’t want to waste time on a scrupulous study of the issuer’s reporting? Then we recommend choosing federal loan bonds or debt securities of organizations with government participation - corporate bonds.

Private companies try to provide extremely favorable conditions for investors (for example, offers with 12-20% per annum), but be careful - unknown legal entities may not be able to cope with their obligations.

Types of bonds

Bonds are divided into many types, let's look at the main ones.

According to the form of income payment

• Coupon (interest) bonds. Provide for the payment of interest on the face value - coupon redemption. For some securities there is only one payment, for others - several. Most coupon bonds are issued with a specific interest rate. However, there is a floating rate when payments change due to reference to macroeconomic figures or stock market conditions.

• Discount bonds. The nominal cost of acquiring these assets is lower, but they are repaid according to their nominal value.

Discount is the difference between the posted price and the nominal value.

IMPORTANT!

If the full price of a bond is 1,000 rubles, and you bought it at a discount for 700 rubles, at maturity you will receive 1,000 rubles. - its entire face value.

By maturity

Depending on the term, the following types of bonds are distinguished:

• short-term - from several months to 1 year;
• medium-term - from 1 year to 5 years;
• long-term - over 5 years;
• perpetual - do not have a specific validity period, but can be bought back by the issuer on pre-agreed conditions;
• Other possible combinations of these options are provided.

By issue currency

The issue of bonds can be carried out by the issuer in ruble and foreign currency equivalent.

By issuer

Depending on the initiator of the debt issue, several types of bonds are distinguished.

State

The coupon rate is affected by the Central Bank rates.

Government bonds are issued for several reasons, here are some of them:

• finance the budget deficit;
• raise money for government programs in the field of housing improvement, social security and other tasks;
• regulate economic activities: money supply in circulation, impact on inflation, economic growth.

ATTENTION!

The most reliable debt obligations are OFZ (federal loan bonds). Coupons for them are not subject to personal income tax.

Regional and municipal

The issue is used to fund local projects. The average coupon for them is approximately 8% per annum, and the reliability is high: if the entity encounters difficulties, the state can pay off the debt. The liquidity of these assets is low.

Corporate

They are produced by commercial companies to attract financial resources from private investors. Coupon rates range from approximately 4 to 12% per annum, and when choosing, you should weigh the risk and solvency of the issuer.

Eurobonds

Debt securities denominated in foreign currency. Interest rates on them range from 4 to 6% per annum in US currency and approximately 3% in euros.

Commercial

Sometimes private firms post this special type of paper. Distribution takes place in a targeted manner and by closed subscription. You won't be able to buy them on the stock exchange.

By convertibility

If it is possible to exchange them for other securities, there are:

1. Convertible bonds. They give the right to exchange for other assets of the enterprise, for example, shares.
2. Non-convertible bonds. Simple bonds that do not give the right to exchange them.

IMPORTANT!

In accordance with Russian legislation, bonds may be converted into bonds with other characteristics, into ordinary or preferred shares.

By security

According to this parameter, bonds can be of the following types.

Secured

Investment safety can be ensured by:

1. Collateral in the form of real estate, company equipment and other assets. If the issuer goes bankrupt, the investor will take back—sell—the collateral and recoup the money spent.
2. Guarantee from a third party. If the issuer goes bankrupt, this guarantor will assume the obligations under the promissory notes.
3. State or municipal guarantee. Similar to a guarantee, but in this situation the debts on the securities will be transferred to the bank, local or federal budget.

Unsecured

When a company goes bankrupt, security holders wait until the bankruptcy process is completed. Further, their claims are satisfied in a regulated manner along with other creditors of the enterprise.

ATTENTION!

The return of the full amount of invested funds is not guaranteed.

Unsecured (subordinated)

In the event of bankruptcy of the enterprise, the investor can return the invested money to the last one after paying the creditors. By this point, funds may no longer be enough. In addition, if the company has not yet gone bankrupt, but has only reached the point of reorganization, unsecured bonds are written off to zero. Here their owner will not receive payments.

By method of circulation

Bonds are:

• with free circulation - there are no restrictions on the acquisition and sale of these bonds. Transfer from one owner to another is allowed;
• with limited circulation - the acquisition and sale of these bonds are limited. They are not allowed to be sold during a certain period, or the issuer sets limits on the value of the securities.

What bonds can you buy in the Russian Federation?

Currently, three types of bonds can be purchased in Russia:

State - the issue of these reliable securities is carried out by the state, the redemption of such bonds is also guaranteed by the state.

Municipal - these bonds are issued by local authorities, and income from such bonds is not taxed.

Corporate - these bonds are issued by large banks (Sberbank, VTB, etc.) or commercial organizations to finance projects.

Differences between bonds by yield

Discount bonds imply full repayment by the issuer on time, while fixed-rate bonds imply regular payment of profit in the form of a percentage of the face value. Floating rate securities provide a constant payment of profits and the interest rate is determined by economic indicators - usually the interest rate on loans.

How to make money on them?

The buyer becomes familiar with the profitability of the bond upon purchase. The security has a coupon payment schedule. In addition, it is not necessary to wait for the paper to expire; you can sell it at any stage. The price of a bond will be influenced by the current economic situation, in which there is a chance of both making money and incurring losses.

In 2022, earnings on Russian Government Bonds range from approximately 5 to 11% per annum, on securities of small commercial companies up to 18%.

Attention! When the yield is high, the price of the bond is usually low.

Bond yield

The yield percentage is stated for the year, and the bond usually matures at par. For example, if the yield of a bond is 7%, and its maturity is 3 years, this means that for 3 years you will receive 7% annually.

The current yield indicates how much you would earn if you bought and sold a bond at its current value, while the yield to maturity indicates how much you would earn if you held the security to maturity.

Tip: If you want to receive payments monthly, you can purchase 6 bonds from different issuers that pay coupons twice a year - this way you can regularly receive coupon income and reduce the risk of losses.

To calculate bond yields, you can use the calculator available on the Moscow Exchange website.

Calculation of coupon bond yield

Let's complicate our example. Let's say a security comes with a 5% coupon. That is, payments will no longer be 1000 rubles, but with a coupon of 50 rubles.

We calculate the total amount of what will be paid in a year. We take 1000 rubles of face value and add 50 rubles for a total of 1050 rubles.

We insert the result into our basic formula and get:

The resulting amount is 1050 rubles minus what was invested 950 rubles equals 100 rubles, divided by what was invested, that is, by 950 rubles and multiplied by 100% equals 10.52%.

Where to open an account

An account can be opened at a bank or with a broker. Sberbank, Promsvyazbank, VTB and other banks charge commissions, but have a minimal risk of default. The most popular brokers are BCS World of Investments and Tinkoff Investments.

Bonds are traded on the stock market and are considered a worthy alternative to bank loans - bonds eliminate bank margins and allow you to attract cheaper loans directly from investors. The denomination of the bond and the price do not always coincide. If the value of a security is 100% of the par value, then the price of the bond and the par value are equal. If the denomination of the bond is, for example, 1000 ₽, and the price is 102% of the denomination, then you will be able to purchase the bond not for 1000 ₽, but for 1020 ₽. If the value of the bond is less than 100% of the face value, then you can spend less money and earn more. The current price of a bond is determined by the market - if the bond is in demand, then its value increases accordingly.

Yields fell - prices rose. I'm not kidding?

This is true. However, for novice investors who do not clearly understand the difference between yield to sale and yield to maturity, this is often a difficult point. If we consider bonds as a portfolio of investment assets, then its profitability for sale in the event of a rise in price, like shares, will, of course, increase. But the bond yield to maturity will change differently.

The thing is that a bond is a debt obligation, which can be compared to a deposit. In both cases, when purchasing a bond or placing money on deposit, the investor actually acquires the right to a stream of payments with a certain yield to maturity.

As you know, interest rates on deposits rise for new depositors when money depreciates due to inflation. Also, the yield to maturity of a bond always rises when its price falls. The reverse is also true: the yield to maturity falls when the price rises.

Beginners who evaluate the benefits of bonds based on comparisons with stocks may come to another erroneous conclusion. For example: when the price of a bond has increased, say, to 105% and has become more than the face value, then it is not profitable to buy it, because when the principal is repaid, only 100% will be returned.

In fact, it is not the price that is important, but the bond's yield - the key parameter for assessing its attractiveness. Market participants, when bidding for a bond, agree only on its yield. The price of a bond is a derivative of its yield. In effect, it adjusts the fixed coupon rate to the rate of return that the buyer and seller have agreed upon.

See how the yield and price of a bond are related in the video of the Khan Academy, an educational project created with money from Google and the Bill and Melinda Gates Foundation.

How to choose a briefcase

To create a bond portfolio, you should consider the type of debt and its maturity. Experts recommend creating portfolios with different combinations of maturities (from one to thirty years) and various bonds (state, municipal, etc.).

A popular passive investment strategy is the bond ladder - it is used to diversify a portfolio of fixed income bonds by purchasing bonds with a staggered maturity. As they mature, the funds will be reinvested in new bonds, allowing you to maintain the average portfolio maturity at the same level.

An example of forming a bond portfolio

To protect funds from inflation, you can create a special portfolio, which will be an excellent alternative to a bank deposit and will provide a return of 7-11% per annum. For a defensive portfolio, you should buy bonds from reputable issuers that you can hold to maturity—for example, if you're investing for one year, you should look for bonds that will mature within one year. The composition of the portfolio needs to be reviewed approximately twice a year in order to add income bonds on time.

How to reduce all risks to a minimum?

Risks and returns are interrelated. An investor will not receive much income when buying bonds with minimal risks - this is the law of the market.

The most reliable and stable are government debt receipts, in particular OFZs issued by the Ministry of Finance.

The assets of large concerns with a high credit rating and an average level of profitability are considered slightly less reliable.

You can experiment and buy income bonds with an average “B” rating. However, the investor must consider the risk of default, debt restructuring and liquidity.

IMPORTANT!

Before buying bonds, you should definitely analyze the reliability of the issuing company. Read the news and study available accounting and financial documentation - this information is publicly available on the websites of the fund and news agencies.

Where to buy bonds

Bonds are considered an excellent asset for investing money in order to make a profit. If you decide to purchase bonds, the smart decision would be to open an account and purchase securities through a broker. A broker can be a bank or an organization licensed by the Central Bank of the Russian Federation. Investing in bonds can help minimize losses if stock markets fall sharply.

The purchase and sale of bonds can be carried out online - in the broker’s mobile application or through a terminal installed on a personal computer. The bond can be sold before it expires (in which case you can receive your funds while the other person continues to receive coupons). People's bonds are usually distributed among private investors - agent banks.

Briefly about bonds

A bond is a financial debt instrument. Bonds are issued by companies and governments to attract loans. The buyer of the bond receives interest income for as long as he owns it.

The one who issues bonds is called the issuer, and the one who buys them is called the investor.

Each bond has the following parameters:

• Denomination Cost of one paper. For example, 1000 rubles. When you buy one bond, you are lending the company (or government) an amount equal to its face value.
• Coupon. The amount accrued on one bond for a certain period of time (coupon period). The period can be 6 months, 3 months and 1 month. This means that the bond holder receives from the issuer an amount equal to the coupon once per period simply for being the holder of this security.
• Maturity date. The date on which the issuer undertakes to repurchase the bond, i.e. pay the debt off.

All these parameters are set at the time the bonds are issued and cannot be changed in the future, with the exception of individual cases, which we will not consider in this article.

Taxes on profits from bonds

Bonds are characterized by much lower risks than shares, various underlying assets and derivatives, but coupon income is subject to taxation. Income tax is paid on coupon income and on the price difference, but in different tax periods. From January 1, 2022, tax must be paid on all bonds - the rate is 13% for residents and 30% for non-residents. The difference between the nominal and market price with a quote of 100% or more in the case of a bond sale will also be considered income on which you will have to pay personal income tax.

Tip: If you are going to make money on bonds, it is important to remember that brokers withhold tax automatically. Please note that for securities issued before 01/01/2012, the tax is withheld by the issuer, not the broker.

What does the coupon rate indicate?

The coupon rate is the base percentage of the bond's face value, also called the coupon yield. The issuer announces this rate in advance and periodically pays it on time. The coupon period of most Russian bonds is six months or a quarter. An important nuance is that the coupon yield on the bond is accrued daily, and the investor will not lose it even if he sells the paper ahead of schedule.

If a bond purchase and sale transaction occurs within the coupon period, the buyer pays the seller the amount of interest accumulated since the date of the last coupon payment. The amount of this interest is called the accumulated coupon yield (ACI) and is added to the current market price of the bond. At the end of the coupon period, the buyer will receive the coupon in its entirety and thus compensate for its expenses associated with the compensation of the accrued income to the previous owner of the bond.

Exchange quotes of bonds from many brokers show the so-called net price of the bond, excluding the accrued income. However, when an investor orders a purchase, the NCD will be added to the net price, and the bond may suddenly be worth more than expected.

When comparing bond quotes in trading systems, online stores and applications of different brokers, find out what price they indicate: net or with accrued income. After this, estimate the final costs of purchasing from a particular brokerage company, taking into account all costs, and find out how much money will be written off from your account if you purchase securities.

How to get a 13% tax deduction

Investing in bonds quite often attracts novice investors. Using an individual investment account (IIA), you can avoid paying income tax on the sale of bonds or receive a tax deduction of 13%.

As you know, the IIS provides for two types of deductions - “A” and “B”. Type of deduction “B” allows you to avoid paying personal income tax on profits from bonds. If you choose type “A”, you will be able to return tax only from 400,000 rubles, the maximum deduction amount is 52,000 rubles. This solution is suitable for investors with official income.

Thus, if you purchase bonds in the amount of 399,999 rubles, you must fill out a tax return in form 3-NDFL, take an extract confirming the transfer to an individual investment account, and a copy of the agreement on opening an individual investment account. Then you should fill out an application for a refund of 13% tax, send this application to the tax office - and wait for the funds to be credited.

How to get the maximum benefit from a sale?

So, as the price rises, the bond's yield falls. Therefore, to get the maximum benefit from price increases when selling early, you need to choose bonds whose yields are likely to decline the most. Such dynamics, as a rule, are shown by securities of issuers that have the potential to improve their financial position and increase credit ratings.

Bonds with long maturities can also show large changes in yield and price. In other words, long bonds are more volatile. The thing is that long bonds generate a larger cash flow for investors, which has a greater impact on price changes. It is easiest to illustrate how this happens using the same deposits as an example.

Let's assume that a year ago a depositor placed money on a deposit at a rate of 10% per annum for three years. And now the bank accepts money for new deposits at 8%. If our depositor could assign the deposit, like a bond, to another investor, then the buyer would have to pay the difference of 2% for each remaining year of the deposit agreement. The additional payment in this case would be 2 g * 2% = 4% on top of the amount of money in the deposit. For a bond purchased under the same conditions, the price would increase to approximately 104% of the par value. The longer the term, the higher the additional payment for the bond.

Thus, an investor will receive more profit from selling bonds if he chooses long bonds with a fixed coupon when rates in the economy decline. If interest rates, on the contrary, rise, then holding long bonds becomes unprofitable. In this case, it is better to pay attention to securities with a fixed coupon that have a short maturity, or bonds with a floating rate.

Investment risks

Like any other instrument, bonds have certain risks:

• Interest rate - this risk depends on the key rate of the Central Bank (it is noticeable when the average market rate on bonds with similar conditions increases).
• Reinvestment risk - this risk occurs when interest rates fall over a long period of time.
• Default - this risk is recorded if the issuer for any reason cannot fulfill its obligations under bonds and declares itself bankrupt.
• Inflation risk - This risk is due to the fact that the bond yield and actual return can sometimes be different (for example, with a bond interest rate of 9% and inflation of 11%).
• Foreign exchange - investments can be made in rubles, euros or dollars, so it is important to remember that investing in foreign assets depends on the dynamics of exchange rates.
• Credit - a decrease in the issuer's solvency affects its reputation in the market.
• Liquid - this risk is possible when the issuer is poorly known and there is a small number of transactions with its bonds.

What parameters to pay attention to

Key points to pay attention to when choosing bonds:

1. Coupon rate. This indicator gives the buyer information about how much income he will receive while holding the bond for the period before its maturity. Cash is accrued daily (NKD), payments are made quarterly or semi-annually. The most profitable bonds are those where the coupon size is higher (compared to the purchase price).
2. Market price. This indicator indicates the price of a security on the open market on a certain date or period. The higher the price, the more profitable the bond.

3. 
   Type of coupon. Some coupons are changed according to special algorithms of the issuer; you need to pay attention to this possibility. There are bonds with indexation, for example, OFZ. Some securities will not have a coupon.

4. It must be remembered that there are bonds with an offer. Data on the offer date are always indicated in the issuer’s special booklets. After the date that is set, the bond is written off, and funds arrive within 20-25 days. The coupon exists in a stable state until the offer day; later the issuer changes the rate. This moment reduces risks, but can reduce profitability.
5. Duration. This is a parameter that shows when the investment will pay off. It includes the circulation period of the paper and the possibility of reducing or increasing interest during this period of time. This parameter shows the risk of this investment.

Let's summarize: the pros and cons of investments

As you can see, earnings on bonds look like this: the buyer purchases bonds, becomes their owner - and receives regular income as long as the bonds are in his possession.

Like any other investment instrument, bonds have their own advantages and disadvantages. The main advantages of bonds include reliability (issuers with high credit ratings provide minimal risks of non-payment) and profitability (the interest rate in this case exceeds the average bank deposit). At the same time, government bonds are characterized by maximum reliability, since in this case the state acts as the guarantor of the return on investment. In addition, bonds allow you to maintain profits during long-term sales and have liquidity - if necessary, the investor can sell debt securities at any time at a price close to the nominal price. The main disadvantages of purchasing debt obligations include interest rate risks - in the event of inflation, the real price of bonds will be lower than the nominal value.

To summarize, we note that bonds are a conservative tool for diversifying an investment portfolio, helping to expand the circle of investors and guaranteeing a constant income. To make an informed decision on purchasing bonds, you should carefully study the statements of the selected company and analyze the profit results over the past few years.

Who issues bonds?

Bonds can be issued by the following structures:

1. State and municipal authorities. Government bonds in the Russian Federation are issued by the Ministry of Finance to solve certain problems and finance local projects.
2. Commercial companies. The issue is carried out in order to attract additional investment in the business. Bonds of solvent issuers with high ratings on the securities market are usually called the 1st echelon (“blue chips”), with less reliability - the 2nd and 3rd echelons.
3. Banking institutions. Papers are almost no different from commercial ones. But the buyer needs to take into account that banks determine different levels of repayment priority for investors. If the priority and quality of collateral is low, the risk for the investor increases.

Profitability

The price of a bond on the market is not that important. To assess the attractiveness of a bond, the yield parameter is used.

This is the return that the paper holder receives, expressed as a percentage per annum. There are a number of scenarios in which the yield on the same bond can be different. For example:

• You bought the bond at the initial offering and held it until maturity.
• You bought a bond on the market at a price different from its face value and held it until maturity.
• You bought a bond at the initial offering and sold it after some time on the market.
• You bought a bond on the market and soon sold it on the market.

Since the market price of a security is not constant, but depends on supply and demand for it, for each of these scenarios the profitability of the same security will be different.

Let's figure out what types of returns there are, how they are calculated and in what cases they are used.

Government bonds

Federal loan bonds and securities of federal subjects are more reliable than securities of commercial banks or corporations. In effect, investors lend to the state. “OFZ is the safest instrument in the country at the moment,” says Podsevatkin. “And even the yield on it is higher than on deposits.” According to his calculations, the OFZ maturing in June 2022 will generate a net income of 8.89%.

Investors in OFZs and subfederal bonds will not have to pay personal income tax on coupon income, only on the difference between the purchase and sale prices.

Raiffeisen Capital Bond Portfolio Manager Konstantin Artemov advises investing in OFZ for 3-5 years. “The rates for these terms are higher than for bank deposits, even despite the risk of reinvestment of coupons (in conditions of falling rates, received coupons are reallocated at lower and lower rates),” he says. Government bonds maturing in 2019-2021 will bring a yield of 8.8%.

“An investor can get additional yield relative to OFZs if he considers sub-federal securities, which at the same time carry more credit risks,” says Artemov. According to him, the risk of reinvestment in subfederal and municipal securities is higher, since “the securities mainly have an amortization structure (repayment of the face value in installments).” The investor will receive coupon payments quarterly. Artemov suggests considering for investment such securities as Yakutia-08 (maturity 05.18.2021) with a yield of 9.63%, Bashkortostan-8 (09.18.2020) - 9.56%, Krasnoyarsk Territory - 10 (09.10.2019) - 9, 78%.

Portfolio manager of Alfa Capital Management Company Evgeniy Zhornist recommends securities with a duration of about 4.5 years: Moscow region 35010 (10.0%), Krasnoyarsk region - 12 (9.9%), Sverdlovsk region - 3 (9.9% ). “All three issues were placed within the last month and are therefore quite liquid, which is quite rare for sub-federal borrowers,” adds Zhornist.

Current yield (CY, current Yield)

Bond yield indicator for the current coupon period. It is assumed that the net price of the bond does not change.

Calculated using the formula:

Where,

CY - current yield, % per annum;

C(%) — coupon payments;

P is the net price of the bond, without accrued coupon income.

It is primarily used to estimate cash flows received in the form of coupons, regardless of changes in the bond price and its maturity. In other words, the profit received for the period.

Example.

A bond with a par value of 1,000 rubles and a market value of 110% of the par value (1,100 rubles) gives a coupon income of 120 rubles. At a cost of 1000 rubles, this would give a year or 12% per annum. But since the purchase price is higher than the face value, the yield will be as follows:

CY = (120 / 1,100) x 100 = 10.9% per annum

This type of return is similar to a bank deposit. By opening a deposit for a certain period and depositing a certain amount of money, you know in advance how much profit you will receive at the end of this period.

Tax issue

It is known that coupon income from bonds is taxed at 13%. Corporate bonds issued after January 1, 2022 are exempt from tax if their yield does not exceed the Central Bank refinancing rate by 5%. When purchasing OFZs, coupon income tax is not charged.

An example of calculating benefits on OFZs and corporate bonds, taking into account tax

Suppose the yield on OFZ is 6%, and on corporate bonds – 6.8%. The amount available for investment is 150 thousand rubles. Which bonds are more profitable for investors?

Income from OFZ: 150 * 0.06 = 9 thousand rubles.

Income from corporate bonds: 150*0.068*0.87 = 8.874 thousand rubles.

Thus, if the interest rate on corporate bonds differs slightly from the OFZ coupon yield, it is more profitable to purchase government loan bonds, since they are not subject to income tax.

What is an offer

An offer is the right to present a bond for redemption on a predetermined date. For example, a bond issue for a period of 10 years may have an offer 3 years after placement. In this case, the coupon rate is set only until the offer date, and then the issuer sets a new rate. The investor has the right to demand the redemption of securities by the issuer at par on the appointed date if he does not want to hold them longer. Why does the issuer need this? In order to be able to set a new coupon rate that will be valid after the offer date. Why change the coupon rate? If rates in the economy decrease or the credit quality of the issuer improves, then it can reduce the size of the coupon without risking the investment attractiveness of the security.

Due to the fact that the coupon rate may change after the offer, yields are calculated based on the offer date, and not on the maturity date.

In order to submit a bond for an offer, you need to contact the broker with a corresponding application on the eve of the offer date. The broker may charge a fee for this service.

Extract from the prospectus. As can be seen from the prospectus, the coupon rate at the placement stage is determined only up to the offer date.

An example of calculating coupon yield on a bond

Let's assume that an investor purchased a bond with a 3-year validity period immediately after placement for 980 rubles. The nominal value of the bond is 1000 rubles. The promised income is 9% per annum. What will be the investor's income minus personal income tax?

Calculation

Coupon income: 1000*0.09*3 = 270 rubles.

Exchange rate income when the bond is redeemed: 1000-980 = 20 rubles.

Total income: 270+20 = 290 rubles.

Income minus personal income tax = 290 * 0.87 = 252.3 rubles.

Thus, the investor’s income for a long-term investment of 3 years after repayment of the par value amounted to 252.3 rubles or 8.3% per year.