Retail bonds

What are retail bonds?

Retail bonds are fixed-income securities issued specifically for individual investors. Unlike bonds typically traded among institutional investors, retail bonds are targeted at members of the public. When investors buy retail bonds, they essentially lend money to the issuer in exchange for a specified rate of interest over the bond's life and repayment of the bond's face value at maturity. These bonds are subject to regulatory measures governing public offering procedures, ensuring transparency and investor protection.

Retail bonds explained

Retail bonds are debt securities issued by a company, obligating the issuer to repay the bondholders the principal amount along with periodic interest payments until the bond's maturity date. These bonds operate like an "I owe you," with interest typically paid at fixed intervals such as semiannually, annually, quarterly, or occasionally monthly, depending on the bond's terms.

Unlike mini bonds, which typically have a fixed holding period until maturity (usually three to five years), retail bonds are usually listed on exchanges, allowing investors to buy and sell them during regular market hours. This listing provides investors with greater flexibility and liquidity. Retail bonds are often traded on platforms like the Order Book for Retail Bonds (ORB), which is part of the London Stock Exchange (LSE).

Due to the stringent regulation they undergo before issuance, investors have ample opportunity to understand the risks associated with retail bonds. This regulatory oversight ensures that retail bonds are subject to higher levels of scrutiny and transparency compared to mini bonds. Consequently, investors can make more informed decisions when investing in retail bonds, knowing that they are backed by regulatory safeguards.

Types of retail bonds

1. Traded Retail Bonds. These bonds are actively traded on the secondary market at a par value lower than traditional corporate bonds. Investors can buy and sell these bonds at market prices, providing liquidity and flexibility.

2. Non-Tradable Retail Bonds. Unlike traded retail bonds, holders of non-tradable retail bonds typically hold them until the maturity date. These bonds are not actively traded on the secondary market and are usually bought with the intention of holding them until maturity to receive the promised interest payments and repayment of principal.

Benefits and risks

Benefits

1. Stable Returns. Retail bonds offer fixed interest payments over the bond's life, providing investors with a predictable stream of income.

2. Capital Preservation. Unlike stocks, which are subject to market fluctuations, retail bonds offer the assurance of receiving the principal amount back at maturity, assuming the issuer does not default.

3. Assured Liquidity. Some retail bond issuers, such as the HKMC, AA, and MTR Corp., offer bonds with assured liquidity, allowing investors to buy and sell them easily.

4. Small Minimum Denomination. Retail bonds often have a small minimum investment requirement, making them accessible to a wide range of investors.

5. Attractive Yields. In a low-interest-rate environment, retail bond yields may be relatively attractive compared to low bank deposit rates, offering investors the potential for higher returns on their investments.

Risks

1. Default Risk. There is a risk that the issuer of the bond may encounter financial difficulties and default on interest payments or fail to repay the principal amount at maturity, resulting in potential losses for investors.

2. Inflation Risk. If inflation rises significantly during the bond's life, the purchasing power of the interest payments and principal repayment received at maturity may be eroded, leading to a decrease in the real value of the investment.

3. Interest Rate Risk. Changes in interest rates can affect the value of retail bonds in the secondary market. If interest rates rise, the market value of existing bonds may decline, potentially resulting in capital losses for investors who sell their bonds before maturity.

4. Credit Risk. Retail bonds issued by lower-rated companies or governments may carry higher credit risk, increasing the likelihood of default and potential losses for investors.

5. Opportunity Cost. By investing in retail bonds, investors may forego the opportunity to invest in other potentially higher-yielding or more liquid investment options, such as stocks or bond mutual funds.

How is the price of a retail bond determined

Firstly, the subscription price of a retail bond, expressed as a percentage of the bond's principal amount, is established on a specified price-fixing date. This date serves as a reference point for determining the bond's price and is crucial for retail investors looking to purchase bonds.

Secondly, the benchmark yield of a risk-free debt instrument, such as government bonds or savings bonds, plays a significant role in determining the price of a retail bond. For example, in the context of retail bond issues in Hong Kong, the price of an individual bond issue may be based on the offer yield of an identified issue of Exchange Fund Notes with a comparable remaining tenor at the price-fixing date.

Additionally, a certain margin is typically added to the benchmark yield to arrive at the final subscription price of the retail bond. This margin accounts for various factors, including market conditions, investor demand, and the perceived risk associated with the bond issuer.

Calculation

The return on bonds is calculated using the concept of yield to maturity (YTM), which takes into account interest payments and the principal amount received at maturity relative to the purchase price.

Yield to maturity represents the annualized rate of return an investor can expect to receive if the bond is held until maturity. It considers both the periodic interest payments and the repayment of the principal amount upon maturity.

As bonds are subject to price fluctuations in response to changes in prevailing interest rates, the yield to maturity reflects these variations in bond prices over time. When interest rates rise, bond prices tend to fall, and vice versa. Consequently, investors may observe fluctuations in the market value of their bond holdings.

Example

An example of a retail bond is the "ABC Corporation Retail Bond Issue." This bond issue is targeted at individual investors, offering them the opportunity to invest in fixed-income securities issued directly by ABC Corporation.

The ABC Corporation Retail Bond Issue consists of individual bonds that have a specified maturity date, during which investors receive periodic interest payments until the bond matures. These bonds are typically listed on the Order Book for Retail Bonds (ORB) or similar platforms, providing investors with liquidity and the ability to buy or sell bonds as needed.

Investors purchasing the ABC Corporation Retail Bond Issue receive the assurance of stable returns through fixed interest payments over the bond's life. Additionally, they benefit from the potential for capital preservation, as the principal amount invested is repaid at maturity, assuming the issuer does not default.