Account

New to ADSS? Open an
account now to get started.

OR

Already have an account?

Add funds to your ADSS account

Account

New to ADSS? Open an
account now to get started.

Add funds to your ADSS account

Trends & Analysis
News

Gold closes week higher on rate cut speculations

News

Week Ahead Preview: 20th of May

News

Walmart’s stock hits record high on Q1 results

News

Crude oil rises on US supplies, inflation data

News

Another nice quarter for NVIDIA?

News

Alibaba delivers earnings miss, shares slide

Trends & Analysis
News

Gold closes week higher on rate cut speculations

News

Week Ahead Preview: 20th of May

News

Walmart’s stock hits record high on Q1 results

News

Crude oil rises on US supplies, inflation data

News

Another nice quarter for NVIDIA?

News

Alibaba delivers earnings miss, shares slide

Learn

An Introduction to Bonds

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

Introduction

Bonds are one the most important categories of financial asset, yet they are sometimes neglected by traders. In 2020, the total outstanding value of all current bonds was over $120 trillion, considerably more than global GDP. Bond issuance is dominated by government debt, with the major markets of the USA, China and Japan responsible for the lion’s share. The corporate debt market – bonds issued by companies as opposed to national governments – accounts for just 30% of total outstanding debt, and is more evenly spread out, with the US and China the largest issuers but other major economies also accounting for a large portion.

For most private investors, bonds are the second asset class of their portfolio, behind equities, and act as a hedge against market downturns. For CFD traders hedging is not a concern, but bonds are still of interest when they trade away from parity, which happens in two main occasions, during credit scares or when demand is so high that they trade above par. Because CFD traders do not own the underlying security, CFD bond traders do not receive a coupon from their positions.

 

What are bonds?

Bonds are debt instruments, sometimes called fixed income securities because they pay a fixed payment or ‘coupon’ until expiry. They are among the oldest financial instruments, and are the main method of financing for both corporates and governments who need to spend more cash than they have to hand. Bonds are issued with a fixed maturity, and in almost all cases make a regular cash payment known as a coupon. The coupon represents a contract to pay a fixed sum for the duration of the bond, and to return the original sum invested, known as parity or the par value, except in case of default. Par is almost always expressed as 100, so a bond with a coupon of $5 will return $5 each year (payments are often more frequent but annualise to 5%) and return $100 for each $100 invested at maturity. Because bonds mature at par, the price of a bond will steadily move towards 100 as expiry approaches, unless a default is underway.

Bonds are issued as part of the normal course of business operations by governments, including local or city governments as with municipal bonds, and by private companies. Debt financing is often preferred to equity, because the owners do not have to give up any of the company to outside investors. The ability to issue debt depends on a company or state’s credit rating, a figure set by a small number of internationally recognised ratings agencies, which characterise different companies, nation states, and individual securities as investment grade or not, as well as finer subdivisions within these categories. Issuers with the highest credit ratings (normally AAA, though the exact scale varies from agency to agency) are considered to have the lowest credit risk; that is, they are unlikely to default on the debt. This means they can issue securities at a lower cost, with investors in the debt market demanding a lower coupon to take on the credit risk of the issuer.

 

Types of bond

Bonds are normally categorised according to their issuer. The two main distinctions are investment grade / non-investment grade and government / corporate. Investment grade bonds are those that meet minimum standards for credit worthiness and are considered likely to repay their full par value at maturity, whereas non-investment grade bonds have a greater risk of default.

Though credit rating agencies do not have a 100% perfect track record, especially not when it comes to complex debt instruments such as bundled mortgages, it is rare for an investment grade bond to default and essentially unheard of for top-rated bonds to do so. Investment grade bonds are a risk off asset, which traders rotate into during times of market turmoil, while non-investment grade bonds are a risk on, speculative asset that perform well when the overall economy is good and suffer in downturns.

The different types of issuer also trade differently, with the debt of major national governments taking the role of safe haven asset, while the debt of smaller or more unstable countries or corporates exhibiting more risk on characteristics.

 

Treasury bills and bonds

Treasury bills are short-term debt instruments denominated in the US dollar, the global reserve currency, and issued by the American government that pay interest at maturity. They are considered essentially risk free, and the T Bill rate is used to set the ‘risk free’ rate in financial mathematics. Treasury bonds are longer dated and pay the coupon in regular instalments as with other regular bonds.

Treasury traders buy enormous volumes, and prices are normally expressed as a yield. This is a quoting convention where the expected return on maturity at par is reported instead of the price, which has an inverse relationship with the yield, where falling prices cause increases in yields. In market downturns, equity traders often rotate into this kind of government debt as a safe haven asset, driving down yields and increasing prices.

CFD traders can potentially profit on small price moves on T Bond rates, sometimes using leverage to magnify price moves. Though the risk of vast downwards moves is limited – the US Government is considered for the purpose of international finance a ‘risk free’ borrower – price moves can still catch out unwary traders, especially when leveraged.

 

Gilts and other government bonds

Treasury bonds are the market’s name for American government debt, a similar term is Gilts, which refers to British government debt. Other national bonds – main issuers include China, Japan, France and Germany – are simply referred to as government bonds. In practice all of these issuers trade in a similar way, with more credit worthy countries (as ranked by credit rating agencies) having lower yields. Bond traders deal in the same way as US Government debt, and they exhibit similar price characteristics. Adverse economic news or announcement affecting one country can cause a fall in bond prices as safe haven seeking investors look elsewhere for security, and bond CFD traders can easily share in both upwards and downwards price action.

 

Corporate bonds

Corporate bonds, as the name suggests, are issued by private companies. They may be used to finance normal business operations, as they are often cheaper than bank credit of overdrafts, or may be issued to finance unusual expenditure such as an acquisition or other form of business expansion. The corporate bonds of the largest multinationals are considered creditworthy investments and have a similar price action to government bonds, but because corporates are much smaller issuers than national governments, with fewer options for raising revenue in an emergency, the risk of default is generally higher.

Bonds with low investment grade ratings and certainly non-investment grade ones are risk on assets that are driven up by speculative investors lured in by high coupons or high yields from a bond trading below maturity. If the business environment is benevolent and the company can pay back its debt, this sort of trade can prove profitable, but it is inherently risky and bond holders can be wiped out in the case of a default. Normally a weakening in a bond’s credit profile will lead to investors dumping it on the market, sending (nominal) yields soaring as the price plummets.

Bond CFD traders can share in price action in either direction, so there are interesting – but volatile – opportunities in this market segment.

Bond CFDs

An essential point for bond CFD traders to understand is that they only share in the price action of the bond, that is its fluctuations around parity. Bonds trade at a distance from par (say more than 5 assuming par 100) for two main reasons: elevated demand and credit risk, and assuming no default occurs the bond will expire at parity. Because CFD traders hold positions on the very short term, it is possible to trade in both directions on bonds, whatever their current price level – but be aware of the likely long-term trend towards par, and never trade a bond without understanding the credit worthiness of its issuer. The two types of price action should be traded slightly differently, as explained below.

 

Above par

Bonds trading above par are popular and have low yields, since any return from the coupon is eaten into by the expected price decrease towards par. Some government debt has historically traded at negative yields, meaning investors buy it expecting to lose money.

Bond CFD traders have two options here: they can short the bond, hoping to profit on its expected move towards par, or go long if they believe the price increases have further to go. The price history of the bond can provide some guidance here, but more than other financial markets debt instruments are driven by economic concerns and to trade them successfully requires analysing both the finances of the issuer and the broader economic environment. Very often bonds trading well above par do so because of turmoil elsewhere in financial markets, usually in stocks or junk bonds.

 

Below par

The requirements of bond investors and bond CFD traders are slightly different. Bond investors, as a rule, avoid non-investment grade (or ‘junk’) bonds, because the credit risk means they may lose their entire investment. Credit risk matters to CFD traders too, because a default will result in a sudden fall in the price of the bond, but since CFDs allow for easy trading in both directions, this is not necessarily a bad thing. Bonds trading significantly below parity are seen as risky by the general market, who therefore require a higher return to consider buying them, and bonds below say 90 are usually either in or about to default.

Most bond CFD trading takes place with investment grade bonds, often gilt trading or treasury bills, so defaults are extremely rare. Even so, in some circumstances bonds can trade slightly below par – assuming there is no default, a trader would expect the price to climb back up to bar as the bond approaches maturity.

 

Credit risk and the business environment

A recurring topic for bond traders is credit risk, which is the biggest driver of negative price risk in the debt markets. A bond which defaults will not be redeemed at par: sometimes it will be redeemed at a fraction of par, and in the worst case scenario investors will lose all of their money. Though CFD holders aren’t directly exposed to credit risk, a price move to zero or 50 from par on a leveraged trade will be extremely painful. That means it is normally a bad idea to trade debt instruments that have a risk of default, so investment grade bonds, and especially AAA or equivalent securities are strongly preferred.

Bond and issuer ratings change along with the business cycle, and during recessions it is harder for companies or states to achieve top ratings. Generally, during times of rapid expansion, credit is more easily available, even to issuers who perhaps don’t merit it. When the cycle goes into a temporary downturn, these borrowers often find themselves over-extended and their bonds can either fall in price or sometimes default. Ratings agencies do update their scores for different businesses, but early signs of credit trouble should not be ignored even for well-rated debt. In bond trading credit analysis largely takes the place of technical analysis, though it is also possible to use technical analysis strategies in the debt markets. Some studies claim sovereign debt markets (government bonds) are the most predictable, with Asian credit markets particularly well-suited to technical analysis, a pattern seen elsewhere in the forex market. Even so, use of technical strategies must be backed up with fundamental analysis to identify the current position of the business cycle, as well as geopolitical events or any upcoming news announcements. When trading small price moves around par with leverage, even little influences can end up having a big impact on your overall position.

 

Conclusion

Bonds trade very differently to equity CFDs or forex. Trading bonds requires an understanding of credit worthiness, the issuers business model and finances, and debt market dynamics.

ADSS CFD trading platforms allow investors to trade contracts based on the price movements of important debt contracts, but to do so potential traders need to be familiar with the different categories and ratings of bonds.

This introduction to bonds has covered the key categories: government, municipal and corporate; and investment vs non-investment grade. How you trade will depend on the category of bond, its expected maturity, and technical analysis based on recent price action. Not as popular as better known CFD markets like forex and equities, bond CFDs still have an interesting niche for traders looking to gain exposure to new markets.

FAQs

What are municipal bonds?

Municipal bonds are debt instruments issued by local governments, such as a city, region, or district. In some jurisdictions there are favourable tax implications for buying municipal bonds, which increases their popularity in those markets. In many large bond-issuing countries, local councils and city authorities are notorious for poor budgeting, so bond investors should proceed with caution. As always, CFD traders can profit off price falls as well as prices.

When does bond market trading take place?

Some bonds trade on exchanges, with the NYSE offering bond trading between 4am and 8pm Easter Time. Most trade on the secondary market, so you can buy and sell them whenever there is a market maker willing to offer a price. In practice, liquidity is greatest during market trading hours for the issuer country, though products like T Bills can be traded around the clock. To get started, you can create a CFD trading account with ADSS.

How does treasury or gilt trading differ from corporate bonds?

Corporate bonds offer a wider range of credit scores, coupons, and yields than gilts or Treasury bonds. Highly rated government debt tends to have low yields (except for very long dated securities such as thirty-year bonds), so risk on investors seeking high yields look elsewhere. This means some, but not all, corporate debt instruments may trade in correlation with growth stocks and commodities, while credit-worthy sovereign debt will behave more like gold or reserve currency FX.


Site by Pink Green
© ADSS 2024


Investing in CFDs involves a high degree of risk that you will lose your money due to the use of leverage, particularly in fast moving markets, where a relatively small movement in the price can lead to a proportionately larger movement in the value of your investment. This can result in loses that exceed the funds in your account. You should consider whether you understand how CFDs work and you should seek independent advice if necessary.

ADS Securities LLC (“ADSS”) is authorised and regulated by the Securities and Commodities Authority (“SCA”) in the United Arab Emirates as a trading broker for Over the Counter (“OTC”) Derivatives contracts and foreign exchange spot markets. ADSS is a limited liability company incorporated under United Arab Emirates law. The company is registered with the Department of Economic Development of Abu Dhabi (No. 1190047) and has its principal place of business at 8th Floor, CI Tower, Corniche Road, P.O. Box 93894, Abu Dhabi, United Arab Emirates.

The information presented is not directed at residents of any particular country outside the United Arab Emirates and is not intended for distribution to, or use by, any person in any country where the distribution or use is contrary to local law or regulation.

ADSS is an execution only service provider and does not provide advice. ADSS may publish general market commentary from time to time. Where it does, the material published does not constitute advice, or a solicitation, or a recommendation to a transaction in any financial instrument. ADSS accepts no responsibility for any use of the content presented and any consequences of that use. No representation or warranty is given as to the completeness of this information. Anyone acting on the information provided does so at their own risk.