With the high cost of living in Singapore, earning a little side income from investments probably seems like a pretty good idea – and rightly so! Investments can be valuable assets to us young Singaporeans, as they could help you increase your savings, or plan for retirement in the future. However, with the plethora of options available in investments, it is easy to feel paralysed by indecision and give up. In this article, we will walk you through some key factors to consider when looking at corporate bonds in Singapore. But first, you should first understand how corporate bonds in Singapore work in the first place.
1. Understanding the Basics about Investing in Corporate Bonds in Singapore
In its simplest form, investing in corporate bonds in Singapore is loaning money to companies to grow their businesses. At the time of investing, you would already know two essential pieces of information about the corporate bond:
- The interest rate. This indicates how much money you would earn from the bond as a percentage of your initial investment.
- The duration of the bond. This refers to the period of time that would have elapsed before your bond matures and the company returns you the loan.
However, one more essential piece of information exists in any corporate bond, which is unfortunately, impossible to know before you invest. This third piece of information is the risk of investment. This is the likelihood that the company defaults on its payment and fails to fulfill their agreement with you.
You see, once you have invested in the company’s bond, they are free to use the money however they see fit. Simply put, once you have invested, there is little you can do to ensure the company’s continued growth. Should the company go out of business, it could default on their payments, and you would lose the money you initially invested. On the flip side, if the company remains active, you would typically receive interest payments biannually throughout the duration of your bond, and get back all the money you initially invested after that period has elapsed.
You can now see that there are three key players in the world of corporate bonds in Singapore: Interest Rate, Duration, and Risk. These players work together to determine the attractiveness in corporate bonds in Singapore.
2. Know What Makes a Bond Attractive: The Three Key Players – Interest Rate, Duration, Risk
For corporate bonds in Singapore, the following are often considered attractive: high interest rate, shorter duration, and low risk. However, these three key players exist in a delicate balance in the world of corporate bonds in Singapore. This balance is the focus of the next few sections.
3. Know the Relationship Between Interest Rate and Risk in Corporate Bonds in Singapore
As mentioned earlier, the interest rate is information you would want to know before investing in corporate bonds in Singapore. But what does an interest rate mean? Well, we’ve all heard the old adage: “No risk, no reward!” While this proverb may seem to be a cliché, it is true in the world of corporate bonds in Singapore. This is because in general, high-risk investments have high interest rates.
The reason for this is simple: In the world of corporate bonds in Singapore, there is a tradeoff between risk and reward. After all, why would someone invest in a high-risk bond when there are plenty of low-risk ones available? Logically, without the promise of a higher reward (in the form of interest rates), they would not. Thus, companies with higher risk of defaulting on payments must offer high interest rates to make investing worthwhile. Conversely, stable companies do not offer high interest rates in their bonds, since the low risk is incentive enough.
4. Know the Relationship Between Interest Rate and Duration in Corporate Bonds in Singapore
Of course, the duration of the bond plays a role in determining the attractiveness of the bond as well. After all, in today’s fast-paced world, we often wish to see returns of any investment as quickly as we can. As a result, the bond duration is also positively correlated with the interest rate for corporate bonds in Singapore. Just like the situation with risk, longer durations make corporate bonds in Singapore less attractive. This is because from the longer wait time to see returns, long durations also increase the risk of investing. After all, would a company be more likely to see a downturn in one year or fifteen years? Since downturns can lead to companies defaulting on payments, companies offer higher interest rates to make long bonds worthwhile. Naturally, this means that corporate bonds in Singapore with short durations have lower interest rates as well.
As such, for corporate bonds in Singapore, each of the three key players carries a tradeoff. This is because interest rate is positively correlated both with duration and risk alike. This makes it impossible to get the best of both worlds between interest rate and either of the other players. How, then, should we go about deciding which corporate bond to invest in?
You see, while we may now understand the main workings that underlie the world of corporate bonds in Singapore, the scenario in the real world is a little more complicated. In fact, it is not unheard of to see highly stable companies offering high interest rates. Likewise, small companies may occasionally offer poor rates as well, even though these situations are far less common. With the diversity of corporate bonds out there, how do we compare them to decide which to invest in? To do this, we need to find a way to quantify each of the thee key players.
5. Compare the Interest Rates and Durations
Of the three key players, the interest rate is the easiest factor to quantify in any corporate bond. Before you invest in any of the corporate bonds in Singapore, information on the interest rate is often explicitly stated. Similarly, the duration of the bond will also be explicitly stated before you commit to investing in the company’s bond. Therefore, if you are deliberating between multiple corporate bonds in Singapore, these known factors would be easy to compare. After all, one simply needs to choose the bond with the highest return in the shortest period of time.
The true challenge in deciding on a corporate bond lies in evaluating the risk of your investment. At first glance, this task may seem impossible. How does one begin to guess what the fate of the company will be in a few years? Well, while it is impossible to be completely certain, several indicators do exist to hint at the risk of investing.
6. Evaluate the Unknown Risk by Company Identity
The simplest and most straightforward indicator of risk in corporate bonds is the identity of the company. In every country, a hierarchy exists among companies. Thriving companies that are likely to remain active far into the future are the most stable entities with the lowest risk. On the flip side, smaller businesses are less stable since they have a higher risk of going out of business in the near future.
In general, the most stable entities in our country is our government and all its associated agencies. Consequently, even government bonds with long durations often have the lowest risk, and the lowest interest rates. Following closely behind the government in the hierarchy are government-linked companies, such as Keppel Corporation, Sembcorp, and Wildlife Reserves Singapore. Enormous, multi-national corporations (MNCs) based in Singapore such as DBS are often making stable profits as well. As a result, all these entities tend to give corporate bonds with interest rates that tend towards the lower end of the spectrum.
On the other hand, local and family run businesses are often considered to have higher risks than the aforementioned entities. As a result, these corporate bonds are often accompanied by higher interest rates as compared to their more stable counterparts.
7. Evaluate the Unknown Risk by Credit Rating
Another method we often use to evaluate risk is the credit rating of the company. As compared to company identity, this is considered a far more reliable way to determine the risk of a bond. In fact, several global indicators can give a numerical value to quantify the credit quality of a company. Singapore’s most often-used rating system is Moody’s Rating. Other systems used can also include Fitch’s Rating system.
8. Decide on Your Bond
All this said, it is still up to you to decide on how much risk you are willing to take on. Some investors are willing to invest hefty sums into high-risk bonds because they believe in their parent company’s future growth. Others prefer to stick to the safe side, and only invest in low-risk bonds despite their low-interest rates. Thus, we must remember that in the world of corporate bonds, there is no fixed right answer for every situation.
9. Consider Various Ways to Earn Money from Corporate Bonds in Singapore
As mentioned, the most basic way to earn money from corporate bonds is by waiting for the bond to mature. However, there is another, potentially more lucrative way to earn money from corporate bonds: bond-trading.
In bond trading, the market for corporate bonds comes into play. We can think of this market as something of a Carousell for corporate bonds. In other words, when you buy the bond from the company, it still works in the ways we have discussed. You could wait for it to mature to receive whatever amount the company has promised you.
There is an alternative, though: selling your bond to other buyers. In the bond market, trends are always fluctuating, and certain fluctuations can suddenly make your bond far more desirable. In this case, other buyers on the market could be happy to pay you more than what you paid. Naturally, the converse is also true. Market fluctuations could also make your bond less desirable, which would lower the market value of your bond. Of course, this concept could be confusing, so it might be easier to examine bond trading with an example.
Imagine you have bought a corporate bond that would mature in 10 years, with some fixed interest rate. However, in two years, the market conditions changed such that new bonds purchased have a far lower interest rate. Now, your bond is earning more interest than any new bond that is out in the market. Thus, to other buyers, your bond becomes more desirable, and they would be willing to pay you more. Conversely, if market interest rates rise higher than that of your bond, your bond would decrease in value.
In truth, the world of corporate bonds is incredibly complex, and you could encounter a variety of situations in the real world. Nevertheless, this article does encompass the key workings of corporate bonds in Singapore. With these new insights on how you could get a side income with bonds, what are you waiting for? Get out there and begin your first investment portfolio!
New to investing? You can also check out Top 10 Investing Basics in Singapore for Newbie Investors.