Corporate bonds Vs Municipal bonds

What are Bonds?

Put simply, bonds are a loan. It is similar to an IOU because when you purchase
bonds, you are lending money to the entity (normally a government, corporate or
bank) who is issuing the bond (issuer). The issuer is generally obliged to pay interest
at set intervals (coupons) over the bond’s life (term) and then repay the principal
amount (nominal or face value) when the bond matures. This is why they are referred
to as a fixed income investment. So a bond has similar features to term deposits in this
respect.

A bond can be bought and sold on the secondary market, subject to there being
sufficient liquidity in the market. The value or price of a bond may fluctuate due to a
number of factors such as interest rate movements and the perceived credit worthiness
of the issuer.

Government Bonds

A government bond is a bond issued by a national government usually denominated

in the country's own currency. Davy Select gives you access to government bonds
including those issued by Ireland, UK, Europe and the US.

Corporate Bonds

Corporate bonds are issued by companies ranging from large institutions with varying
levels of debt to small, highly leveraged, start-up corporations.

The most important difference between corporate bonds and government bonds is
their risk profile. Corporate bonds usually offer a higher yield than government bonds
because their credit risk is generally greater. This is not always the case, however, as
we have seen more recently.

Example of a Corporate Bond

Bank of Ireland 4% 01/2020: This is a Bank of Ireland bond with a 4% coupon

which should mature in January 2020. For example, suppose you bought 100,000
nominal at a price of 100.00. This means that you should receive a coupon of €4,000
(4% of 100,000) every year until you sell the bond or else until the maturity date in
2020.

Examples of Government Bonds

Irish 5% 18/10/20: This is an Irish Government Bond with a 5% coupon that matures
in October 2020. For example, suppose you bought 100,000 nominal at a price of
100.00. This means that you should receive a coupon of €5,000 (5% of 100,000)
every year until you sell the bond or else until the maturity date in 2020.

DBR 2.50% 04/01/21: This is a German Government Bond with a 2.50% coupon that
matures in January 2021. For example, suppose you bought 100,000 nominal at a
price of 100.00. This means that you should receive a coupon of €2,500 (2.5% of
100,000) every year until you sell the bond or else until the maturity date in 2021.

Note, the prices quoted in the above examples will vary over the lifetime of the bonds.

Yield

Yield is the annualised return that is earned on a bond, based on the price paid and the
interest payments received. There are many different ways to measure a bond's yield,
the most common is yield to maturity. This is the total return an investor will receive
by holding a bond until it matures, including all the interest received from the time of
purchase until maturity, plus any gain or loss if the bond was purchased at variance to
its par value.

It should be noted that a bond's price will fluctuate during its lifetime and that this
will impact its yield. A bonds yield moves inversely to its price. When a bond's price
rises, its yield decreases and conversely when a bond's price falls, its yield increases.
From the above example, of the Irish 5% 18/10/20, if it is purchased at 100 (PAR) per
100 nominal it will have a yield to maturity of approximately 5.00%. However if it is
purchased at a discount, for example 90 per 100 nominal the yield rises to
approximately 6.31%.

Risks

Investing in Bonds is not without risk. Bond prices can be volatile. The overall market
may fall, or the Bond that you invest in may perform badly. The value of your
investment may go down as well as up. Past performance is no indication of future
performance. Investments denominated in a currency other than your base currency
can be affected by exchange rate movements when converted back to the base
currency.

Credit Risk: This is the risk that an issuer will be unable to make interest or principal
payments when they are due, and therefore default. Rating agencies such as Moody’s,
Standard & Poors (S&P) and Fitch assess the credit worthiness of issuers and assign a
credit rating based on their ability to repay its obligations. Fixed income investors
examine the ratings of a company in order to establish the credit risk of a bond.
Ratings range from AAA to D. Bonds with a ratings at or near AAA are considered
very likely to be repaid, while bonds with a rating of D are considered to be more
likely to default, and thus are considered more speculative and subject to more price
volatility.

Inflation Risk: Inflation reduces the purchasing power of a bond’s future coupons
and principal. As bonds tend not to offer extraordinarily high returns, they are
particularly vulnerable when inflation rises. Inflation may lead to higher interest rates
which is negative for bond prices. Inflation Linked Bonds are structured to protect
investors from the risk of inflation. The coupon stream and the principal (or nominal)
increase in line with the rate of inflation and therefore, investors are protected from
the threat of inflation.

Differences between government bonds and corporate bonds

Now that we have explained the various characteristics of government and

corporate bonds, we can look at how they differ.
A major difference is liquidity, which will be much lower for corporate bonds, since
the volumes of government bonds issued are much higher.
Another difference is the minimum investment. In a government bond issue, the
minimum investment may be €1,000, whereas for most corporate bonds it would be at
least €50,000.
Lastly, the tax treatment is different: the tax rate on corporate bonds was increased
to 20% in 2012 but remained at 12.5% for government bonds.
A safer bet is to invest in a bond fund
As may be surmised, investing in the bond market requires analysis and expertise. It
is therefore advisable to use a professional company with the experience to choose the
best government and corporate bonds.
The most effective way of diversifying investments and maximising returns is to
select a bond fund managed by expert professionals.

Advantages of Debt Market

 The debt market capitalizes and mobilizes the funds in the economy.
 This market gives a platform to the government, companies, and other bodies
to raise funds.
 Sometimes raising equity becomes very costly for the corporate. In such a
situation raising money through the debt market is the best possible option.
 This market gives fixed returns to investors with lesser risk. Government Debt
Market securities are less risky than Corporate Debt securities.
 In absence of any other sources of finances, the Central/State Government
takes the help of this market. It saves the Government bodies, from suffering
from any cash crunch.
 Debt Market securities backed by assets get the preference as compared to
other unsecured and business debts, at the time of liquidation.
  The money raised through this market helps the companies to boost its
expansion and growth plans.
 The debt market helps the Government authority to boost infrastructural
projects.

Disadvantages of Debt Market

 One of the biggest disadvantages of this market is that it provides fixed returns
to the investors and completely ignores the inflation rate. The inflation can
make the actual return falls down to a record low.
 The second disadvantage is, in the case of premature withdrawal or sell-off in
the market, the investor gets the current market bond’s price and not the
principal amount invested. It is possible that the company might lose its
credibility and the bond prices might have fallen down.
 The investors will get a fixed interest rate return only, irrespective of an
increase in the interest rate in the market.
 For issuing authority, it becomes very difficult to get a good credit rating. This
becomes the biggest task to meet all requirements of credit rating agencies.

Debt Market Vs Equity Market

There are many differences between the Equity Market and Debt Market, which are
as follows:-

Debt Market Equity Market

A debt market is a market place, where
fixed-income securities are traded.
Investors in the Debt Markets are known
as Debt holders.
Debt holders have first repayment
priority at the time of liquidation.
Debt holders are creditors of the
company.
Debt holders do not have any voting
rights.
Instruments of the debt market provide
fixed returns to the investors.
Debt Market instruments are less volatile
in nature. They are less risky than Equity
Market.
Debt Market holders get interest rates, for
their investments.
Equity Market is a market place where
trading of equity stocks takes place.
Investors in the Equity Markets are
known as shareholders or Equity holders.
Equity holders or shareholders have the
last repayment priority at the time of
liquidation.
Equity holders are owners of the
company.
Equity holders have voting rights in the
company.
Equity Market does not guarantee any
fixed returns.
Equity Markets are very volatile in
nature. They are riskier.
Equity Market holders get dividends and
not interest rates.