Terms Beginning With 'b'

Bond Market

What are Bond Markets?

Bond Markets, aka Debt Markets, Fixed Income Markets, are part of capital markets facilitating trading of debt or fixed-income securities. Fixed Income Markets have been a widely used funding source for corporations as well as Governments.

Read: Be The Owner, i.e. Buy Stocks Or Be The Lender, i.e. Buy Bonds!

Fixed interest instruments have been present since ages in some form or type. But bonds grew popular in the early 20th century after the entry on the New York Stock Exchange. In the mid-20s, the market makers developed a penchant for trading bonds in lots to generate a mark-up on the block trades, which were largely sold to investors like insurance companies or banks.  

Bonds are usually traded over the counter (OTC) because of large lots and size of trades. Even exchange-traded bonds also end up at OTC markets because of higher liquidity levels. But derivatives like options, future on bonds and convertible bonds are traded in an exchange.

How are bonds traded?

A new bond offering in the primary market either goes public through auction or bought deal. In a bought deal, the market makers, which include fixed income dealers and investments, bid for the offer and issuer picks up the best deal available.

In an auction, a buyer bids for his/her part of investment in the bond at a certain price, which he/she feels is appropriate after incorporating existing market environment and fair value of the bond. Bond auctions are very popular among investors, and Government bond issues generally undertaken under auctions.

Related: Investors endorse the new 30-year Government Bond sale

After primary markets, the bonds are available in secondary markets but are traded over the counter, unlike stocks in the exchange. Stock exchanges are more transparent than OTC markets because trades are reported on an instant basis.

In OTC markets, the bond dealers engage with investors to undertake a transaction, which is not reported like equity trades are reported in an exchange. Market participants are generally unaware of the latest transactions taken for a bond.

Investors engage with market makers to conduct a bond transaction. Market makers may buy bonds even if they don’t have buyers, and make money by bid-ask spread, which is the difference between bid price and ask price.

Read: Bonds or shares: more to do with an investor's strategy than market scenario

Also read: Global Debt is Increasing Unprecedently; Bond Markets 2020

What are the types of bonds?

Good read: Understanding Debt Securities

Government bonds: Government bonds are the most popular bonds in the bond market and have relatively high liquidity levels compared to other bonds. These bonds can also include with ones having maturity of less than one year to say 30-year bonds.

Since these bonds are issued by Sovereign Governments of the nation, the risk is perceived lower compared to other bond issuers. But the risk within Sovereign bonds is more related to creditworthiness of the issuing country that is denoted by credit ratings.

Related: Investors endorse the new 30-year Government Bond sale

State Government bonds: State Governments bonds are issued by local Government or state Government to fund internal development activities. In the US, the municipal bond market act as a funding source for local as well as State Governments.

Corporate bonds: Corporate bonds are issued by companies primarily to fund capital investment. These bonds are perceived riskier than Government bonds due to the issuer being a private organisation. As a result, the higher risk in Corporate bonds is compensated with a relatively higher return.

Read: Powell Explains Fed’s Business in Corporate Bonds

Pricing and yields of corporate bonds also depend on financial outlook and reputation of the business, while other factors impacting corporate bond prices include interest rates, credit rating of the issuer.

Foreign bonds: A foreign bond is issued by an overseas country in a domestic market in domestic currency. These bonds are called Foreign bonds because they are listed in foreign and denominated in foreign currency. Investors invest in Foreign bonds to diversify portfolios and get better interest rate exposure. But there remains a currency risk depending on exchange rates.

Convertible bonds: Convertible bonds give the holder a right to convert holdings into predefined number common stock. These bonds are issued by corporations and attract investors because of higher yields than government bonds and an option to convent holding into stocks.

Zero-coupon bonds: Zero-coupon bonds do not carry interest rate or coupon. Also called accrual bonds, these bonds are issued at a steep discount since there are no coupon payments, and maturity at full allows to realise a gain in such bonds.

Step-up bonds: Step-up bonds are also issued by corporations, whose revenues are expected to grow in a phased manner. These are called Step-up bonds because the coupon rate is increased after a certain period. Similarly, there are Step-down bonds wherein coupon payments are reduced after a certain period.

Floating Rate bonds: Under these bonds, a part of coupon rate is dependent on a given benchmark rate, which keeps changing. Floating Rate bonds are issued at a base rate + benchmark rate. A benchmark rate could be the yield of 3-month treasury bills. On the interest payment date, the issuer will pay the base rate + the prevailing yield on the benchmark.

Callable bonds: These bonds give a right to the issuer to call back the bonds at a predetermined price and fixed date. As Callable bonds provide right to the issuer to call back at a given date before maturity, the interest rate in Callable bonds is relatively better than other bonds.

Puttable bonds: Puttable bonds give a right to the holder to return bonds at a predetermined date. As Puttable bonds provide right to the holders to return principal at a given date before maturity, the interest rate in such bonds is relatively lower.

Bonds and interest rates

It is also known as interest-rate risks because interest-rate and prices of bonds are inversely correlated. When interest rates are hiked, the price of bonds will go down, and the opposite is true when interest rates are cut.

Must read: Are Bonds really a boring investment option?

Difference between actual and an expected return. For example, if a stock increased by 7% because of some update, but the average market only increased by 3% and the stock has a beta of 1, then the abnormal return was 4% (7% - 3% = 4%)

In the recent past, the absolute return approach of Investing has turned out to be one of the fastest-growing investment strategies worldwide. A lot of financial advisors talk about such investments providing absolute returns. So, what exactly are the “Absolute Returns” and are they are promising? What is meant by Absolute return? Absolute return computes the increase or decrease, in an asset over a period of time, as a proportion of the original investment amount. The focus here is only on that specific asset or portfolio and not related market events. Absolute returns only consider the price movement for any specified time period. Absolute return, reckons an investment’s performance without considering the expanse of time for which investment was committed. Absolute returns can be computed for a quarter, semi- annual, annual period, 3-year duration or more. Absolute Returns are independent of Market movements and thus do not draw relative comparisons. It is one of the most commonly used investment performance metric in Hedge Funds and Mutual Funds. How to compute Absolute return? Suppose an investor Mr. Rich, invested AUD 50,000 5 years back, and the current value of his investment is AUD 75,000. The Absolute return on Mr. Rich’s investment would be 50 %, calculated using- Copyright © 2021 Kalkine Media Pty Ltd Copyright © 2021 Kalkine Media Pty Ltd So, Copyright © 2021 Kalkine Media Pty Ltd Absolute returns are just returns from point of time to other. The notion of an 'absolute return' seems very attractive to get investors’ attention as it ignores the relative market movement and promises an appreciation with zero correlation to markets. Anyhow, Absolute Return technique of computing investment yields is an apt way of calculating return on investment, predominantly in the early stages. There are numerous other types of return metrics an investor can look for later on. Major 4 types mattering most to investors being –  Absolute Return, Relative Return, Total Return & CAGR. What is the difference between Absolute Return, Relative Return, Total Return & CAGR? Absolute return refers to the gain/ loss in a single investment asset/ portfolio but to comprehend how their investments are acting relative to various market yardsticks, relative return is taken into consideration.   Relative return is the excess or deficit an asset achieves over a timeframe matched to a market index. Benchmark Return – Absolute return, gives the Relative return also called sometimes as alpha. Example, if S&P index gives a 10% return during a given period and one’s investment portfolio gives an absolute return of 12% then relative return on investment is positive/ excess 2%. Total returns take into account the effect of intermittent incomes as well as dividends. For example, in an equity investment of AUD 200 having current value AUD 240, the company also declares a dividend of AUD 10 during the year. Total returns will take into account this $10 dividend too. Thus, Total returns on the investment of AUD 200 now will be 25.00% = {(240+10-200)/200} x 100 Absolute and Total returns are easy to calculate as performance metrics, but the real challenge is when comparisons are drawn based on time period of return. Here comes in CAGR, it takes into account the term of the investment too, thus giving a more correct and comparable picture. It is computed as: CAGR (%) = Absolute Return / Investment period (equated in years) Consider for example, two investment options: One where investor earns absolute returns of 10% in 24 months and another where investor earns 5% absolute returns in 9-month duration. So, CAGR would be- For option one: CAGR = 5.00% i.e.  10%/2 (24 months/12 months is equals to 2 years) For option two: CAGR = 6.66% i.e. 5%/0.75 (9 months/12 months is equals to 0.75 years) What’s wrong with just measuring investment performance using Absolute Returns? Absolute returns will only tell an investor how much his/her investments grew by; they do not tell anything about the speed at which investments grew. When people talk about their real estate investments and say, “I bought that house for X in the year 2004. It’s worth 4X today! It has quadrupled in 17 years.” This is an application of absolute return. The drawback here is that it takes into account only the capital appreciation and doesn’t draw comparison with options having different time horizons. Investors can rely on this measure of investment performance only if they are looking for higher returns, without bothering how fast they were generated. Absolute return also doesn’t convey much about an investment compared to relative markets. Then, why do Hedge Fund/ Mutual Fund Managers choose an Investment strategy based on Absolute returns? Absolute returns should be used at times when investors are willing to shoulder some risk in exchange for a prospective to earn excess returns. This is irrespective of the timeframe and Fund administrators who measure portfolio performance in relation of an absolute return typically aim to develop a portfolio that is spread across asset categories, topography, and economic phases. They are looking for below mentioned points in their portfolios- Positive returns- An absolute returns approach of investment targets at producing positive returns at all costs, irrespective of the upside & downside market movements. Independent of yardsticks- The returns are in absolute terms and not in comparison to a benchmark yield or a market index. Diversification of portfolio- With the intention of distribution of risk, among different investment options producing positive returns in diverse ways a mixed bag of absolute return assets give a diversified investment portfolio. Less volatility- The total risk of investment is spread across the different asset held in such a portfolio. Ensuring less overall volatility in collective returns. Actively adjustable to market movements– Usually, investments look for positive returns with zero market correlation. Market shares a negative correlation with absolute return investments and vice versa. In any investment atmosphere, there are varied investment strategies and goals. Absolute return investment strategies are looking to avoid systemic risks using unconventional assets and derivatives, short selling, arbitrage and leverage. It is appropriate for investors who are prepared to bear risk for short and long-term gains.

Refers to most commonly the realty sector and indicates the rate of sale of homes in a certain market during a given period of time. It is calculated as the ratio of the average number of sales in a month by the total number of available homes.

Darvas Box system Every great trader/investor in the history of the markets had a specific method to approach the markets, which eventually led them to create a good fortune, Darvas Box system is one such method. It is a trend following strategy developed by Nicholas Darvas in the 1950s to identify stocks for good upside potential. This is one of the few methods to trade the markets which uses the combination of both the technical analysis and fundamental analysis for a much more refined decision.  The fundamentals were used to identify the stocks, and technical analysis was used to time the entry and exits. Who was Nicholas Darvas? Nicholas Darvas was arguably one of the greatest stock traders/investors during 1950s – 1960s, but surprisingly he was a ball dancer by profession and not a professional stock trader. Even while trading and building his fortune, he was on a world tour for his performances in many countries and took up trading as a part-time job. In November 1952 he was invited to a Toronto Nightclub for which he received an unusual proposition of getting paid in shares by the club owners. At that time, all he knew was there is something called stocks which moves up and down in value, that’s it. He accepted the offer and received 6k shares of a Canadian mining company Brilund at 60 cents per share, with the condition that if the stock falls below this price within six months, then the owners would make up the difference. This was the introduction of a professional ball dancer to the stock market. Nicholas Darvas couldn’t perform at the club, so he bought those shares as a gesture. Within two months, Brilund touched $1.9, and his initial investment of $3000 turned to $11400, netting in almost three times of his investment. This triggered a curiosity into the stock markets, and he started to explore trading. Origin of the Darvas Box theory Initially, he was trading on his broker’s recommendation, tips from wealthy businessmen, he even approached some advisory services or any source that he could get his hands on for the tips, but all led him to losses. After losing a lot of money, he decided to develop his own theory, and after a lot of trial and error, his observations and continuous refinements he eventually invented his theory “The Box Theory”. So what exactly is the Box Theory? Fundamentals Analysis As stated earlier, the box theory uses a judicious bend of both the technical and fundamentals. Darvas believed that in order to spot a good stock or even a multibagger, there should be something brewing up in the respective sector as a whole or some major fundamental change in that specific company. Generally, the fundamentals that Darvas used to study were on a broader sector level, and not the company-specific fundamentals. Even for the specific company Darvas used to look from a general perspective like, is the company launching a new product which could be a blockbuster hit. He completely refrained from looking at numbers and financial statements as his initial experiment with ratios and financial statements didn’t yield any good result. To know more on the three financial statements read: Income Statement (P&L) Balance Sheet Cash Flow Statement Technical Analysis Darvas was a big believer in price action and volume of the stock. He believed if some major fundamental changes were to take place in a company, this soon shows up in the stock price and its volume of trading as more people get interested in buying or selling the stock. With his observations here realized by just observing the price action, he can participate in the rally which gets triggered by some major fundamental development without actually knowing about the change. Using the box theory, Darvas used to scan stocks based on rising volume as he needed mass participation in the rally. Also, he only picked up those stocks that were already rising. His theory is all about “buy high, sell higher” instead of the conventional belief of “buy low, sell high”. After the stock satisfies both the parameters of increasing price and volume with major underlying fundamental change, Darvas looks to enter the stock. Good read on momentum trading. How and where to enter? Major part of the box theory is based on entry and exit levels. To enter a stock, Darvas looked for a consolidation phase preceded by a rally. A consolidation phase is the price action wherein the price moves up and down in a tight range, that is, a non-directional move. He would then mark the high and low of the consolidation phase with the horizontal line, essentially making it a box-like structure, hence the name “Box Theory”. The high point is called the ceiling, and low is called the floor. Whenever the stocks break above the ceiling, Darvas would look to buy one tick above the ceiling with one tick below floor as a stop-loss point. Pyramiding Darvas discovered early on, in order to become successful in the market your winning bets should yield much more profit than the loss in the losing bets. This led him to do pyramiding in his winning trade, which is clearly defined in the box theory. Pyramiding means to increase the existing position if the stock is going in the favour, which leads to a much higher profit in the winning trades. According to the box theory, the repetition of the entry criterion is the new signal for adding onto the existing position. In other words, after a position, if the stocks stage the same setup, that is, a consolidation after a rally, then the break above the ceiling of this new box would signal to increase position with the revised stop loss of 1 tick below the new floor. In any case, whenever the stock falls below the current floor, the entire position would we sold off at once. This is the only exit condition in the box theory, and there is no method of booking profit upfront as Darvas believed in holding on to a rising stock. The only way to book profit is to let the stock to take out the revised stop loss.

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