A coupon is a fixed income paid to the bondholder by the bond issuer at specified intervals. A coupon is expressed as a percentage of the principal amount.
The coupon an issuer has to pay on its bond varies depending on the issuer’s credit quality and credit rating:
Regarding investing, there is a positive relationship between risk and reward, as a higher potential reward is used to compensate investors for taking on increased risk. The general rule of thumb for bonds is that the higher the credit quality of the issuer, the lower the coupon rate on the bond. The reasoning is that an issuer with a high credit quality reflects a low chance of default, making it a low-risk investment, and resulting in less reward (i.e., coupon and yield to maturity) for investors. The credit rating is a reasonable guide to the credit quality of an issuer.
Most bonds issuers, plus bonds themselves, are given a credit rating by a credit rating agency. The credit rating of the bond itself may differ from the credit rating given to the issuing company or country. Generally, corporate bond ratings cannot be higher than the sovereign bonds of the country the issuer is located in.
Any bond that has no rating is known as an unrated bond. One reason this may happen is if the issuer believes their targeted investor audience is very familiar with them and is therefore likely to deem their creditworthiness higher than a bond rating agency would.
There is no single centralised bond rating agency, with multiple ones available. The three main ones are Moody’s, Standard & Poor’s (S&P) and Fitch. The issuers of the bonds themselves are the ones who pay these rating agencies to rate their bonds. To you, this may look like a conflict of interest, but it's in the interests of both parties (the issuer and the rating agency) for the agency to be viewed as impartial. What’s more, they are the only three recognised by the SEC in the US.
S&P and Fitch
Moody’s
There are four credit rating agencies licenced by the MAS in Singapore: the three listed above, and AM Best Asia-Pacific, which is also HQed in the US.
A bond’s credit rating is given on issuance, is not set in stone and may change following a periodic reevaluation. If a bond issuer's credit rating goes down, then they will have to pay higher interest for future issues. Existing investors may lose money based on a lower market price for their bonds, though that would not directly impact the issuer.
Not to be confused with non-rated bonds! Non-investment grade bonds, also known as high-yield bonds, junk bonds or speculative bonds, are considered risky investments. Basically, there is a higher chance the issuer will default, meaning you may not receive the expected coupons or could even lose all your capital. To compensate for such risk, these bonds pay out coupons representing a higher yield.
Bond ratings provide useful information to the markets and play an important role in determining the bonds invested in by both ETFs and mutual funds. The downgrading of a bond to a non-investment grade can cause a mass sell-off event and significantly worsen a bond's price.
Many are sceptical about the potential conflicts of interest surrounding bond rating agencies because bond issuers pay them to provide ratings. Why would any bond issuer pay an agency they thought was going to issue them a low rating? Well, as mentioned previously, it’s in the interests of both parties for the agency to be seen as impartial. What’s more, they are the only three recognised by the SEC in the US.
You can either buy bonds in the primary market, where the bond is created and priced at face value or through the secondary market (e.g. the S&P 500), assuming there is a seller. The secondary market purchasing process is very similar to buying shares through a brokerage platform, meaning it will involve brokerage fees.
Note - any bonds purchased are reflected in your SGX CDP account.
You can either receive the principal at maturity or sell it on the secondary market before maturity (assuming that there is a buyer). Of course, if the issuer of your bond defaults before it reaches maturity, then you may receive nothing.
WHY BONDS DON'T ALL PAY THE SAME COUPON. COMPLETED. ✅
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