If you are already familiar with fixed income in Brazil, you will be pleased to discover that it is also possible to invest in this type of investment in the United States, and in dollars. They are called Bonds.
What are Bonds?
Bonds are debt securities issued by the government or private companies to finance projects, activities or even to refinance other debts. They work like a loan contract, where the issuer undertakes to pay interest to the investor and return the borrowed amount at a future date.
How do Bonds work?
Just like in Brazil, when a company or government needs money, whether to finance a project or to manage its debts, they can issue Bonds on the American market, which are purchased by investors interested in lending money to these entities.
Each Bond has its own characteristics, such as maturity date, interest rate and method of payment of coupons (interest). The loan’s interest rate is determined by some factors, including: the issue’s credit risk, that is, the chance that the issuer will not be able to pay the loan. The greater the risk, the higher the interest rate offered. Risk rating agencies, such as Moody’s, Fitch and S&P, grade Bonds to show how safe and reliable they are. It is also worth noting that the risk classification of some issuers is restricted by the country’s risk classification, that is, no private company in the country will have a better classification than that of the country in which it is located.
American Treasury bonds, called Treasuries, are considered the lowest risk bonds and their rates serve as a reference for other private issues. In the international market, companies that want to issue Bonds need to pay an interest rate above the Treasuries rates, placing an additional increase according to the credit risk, called spread. In Brazil, this same dynamic occurs, where private fixed income bonds are related to Treasury bonds and have an increase in the interest rate, according to the risk and term.
A big difference between the American market and the Brazilian market is that in the USA, the vast majority of bonds have fixed interest rates, while in Brazil, you will find many options indexed to the Selic interest rate and inflation as well.
Investors can choose between holding the Bonds until maturity, when they receive the agreed value, or selling them on the secondary market before maturity, negotiating with other investors at the market price. In the United States, the secondary market is very liquid, which means that it is generally easy to sell Bonds and there is flexibility to adjust positions according to investors’ needs.
Main types of Bonds:
By type of Issuer:
- Government Bonds: Government Bonds are issued by governments, including the United States government. American government bonds are known as Treasuries, and are categorized according to their maturity date, namely Treasury Bills, Treasury Notes and Treasury Bonds.
- Corporate Bonds: Corporate Bonds are issued by private companies when they need to raise funds. These bonds are similar to debentures in Brazil, remembering that in the USA they are generally launched with pre-fixed rates, and are a way for companies to obtain cheaper loans with a greater volume of resources.
By coupon type:
- Fixed Income: Most Bonds are issued with a fixed interest rate and semi-annual coupon payment. The coupon is the amount paid to the investor as interest on the loan and is generally fixed over the life of the Bond.
- Zero Coupon Bonds: These are debt securities that do not pay periodic interest coupons. Instead, these Bonds are issued at a significant discount to their face value and offer only a one-time payment at maturity.
Why invest in Bonds?
- Stable yield: Bonds generally pay fixed interest on a regular basis, providing a predictable income stream.
- Capital Preservation: High-quality bonds are generally considered safer investments compared to stocks and can help preserve invested capital.
- Diversification: Bonds can be an important addition to diversify an investment portfolio, balancing the risks associated with other asset classes.
- Payment priority: In the event of bankruptcy or liquidation of the issuing company, Bond holders have priority over shareholders in receiving payments.
How can Bonds generate returns?
- Interest: Investors receive periodic interest payments called coupons. The interest rate is defined when the bond is issued and is paid by the issuer, generally semi-annually.
- Difference between purchase and sale price (or maturity): If you buy a Bond for a price lower than its value on the day of sale or maturity, you can make money on this difference. On the other hand, if the purchase price is higher, you may incur a loss.
- Coupon reinvestment: When you receive interest payments, you can reinvest that money in other assets, further increasing your profit potential over time. Reinvesting coupons allows compound interest to work in your favor.
Important concepts for evaluating a Bond:
- Coupon: This is the fixed annual interest rate you receive from the issuer. This amount is expressed as a percentage of the Bond’s par value (normally $1,000.00) and is generally divided into semi-annual payments. For example, a bond with a face value of $1,000 and a 5% coupon would pay you $50 in interest per year. In this case, it would be $25 per semester.
- Offer price: This is the price you pay for the Bond. It is generally established as a percentage in relation to the par value.
- Maturity: Expiration date of the asset.
- Yield to Maturity: It is an estimate of the total return if you take the Bond to maturity.
- Yield to call: It is the estimated total return if the issuer chooses to redeem the security in advance, on dates already pre-established in the contract.
- Yield to worst: It is an estimate of the minimum return you can expect if the Bond is brought to maturity or redeemed on a pre-defined date.
- Duration: Represents the average period of receipt, in years, of the cash flows from a given security. This measure of market risk serves the investor to measure the sensitivity of the price of their security vis-a-vis a variation in the interest rate of the asset in the secondary market. In general, the longer the duration, the more a bond’s price will fall as interest rates rise (and the greater the market risk).
- Next call date: if the Bond has an embedded call clause, this information shows the next date on which the issuing company has the right to repurchase the asset. Unlike the Brazilian debt market, repurchase options are very common in the offshore market.
- Investment grade (IG): Issuers that have a credit rating equal to or greater than BBB- by agencies S&P and Fitch, and Baa3 by Moody’s. It is worth emphasizing that in the case of offshore securities, the international scale is used. For reference purposes, Brazil’s sovereign rating (federal government) on this scale is BB- by agencies S&P and Fitch, and Ba2 by Moody’s. (Data valid for the date of posting of this article)
- High Yield (HY): Issuers that have a credit rating below BBB- by agencies S&P and Fitch, and Baa3 by Moody’s. Like IG assets, HY offshore asset ratings use the international scale.
- Seniority: Debt seniority defines a ranking of the company’s debt payments in the event of bankruptcy. Debt can range from senior secured to junior subordinated. The greater the seniority and the guarantees given as collateral, the lower the rate, but the greater the security of receiving the money back.
How much do I need to start investing in Bonds?
With more or less $5 thousand dollars (5 units) you can now invest in a Bond. The value is approximate because Bonds are traded on the secondary market, and their market value may be above or below their face value, which is one thousand dollars per unit.
Risks involved:
- Credit risk: There is a risk that the Bond issuer will default on its interest or principal payments. Assess the issuer’s credit rating and financial health.
- Interest rate risk: Bond prices are affected by changes in interest rates. When interest rates rise, Bond prices generally fall (a rise or fall in the interest rate will not change the coupon payment, only affecting the mark-to-market of the face value of that Bond)
- Liquidity risk: Some Bonds may have low liquidity, which may make it difficult to buy or sell on the secondary market.
Perpetual Bonds:
Perpetual Bonds are a special type of Bond that does not have a pre-determined maturity date. These bonds are considered riskier and generally offer higher interest rates.
Final considerations:
Investing in Bonds in the United States can be an interesting opportunity to diversify your fixed income investment portfolio. But remember that when evaluating a Bond, it is very important to understand your investor profile and carry out a careful analysis before making any investment decision.
Bonds on Avenue:
Variety:
Fixed income from Big Techs, large global companies, financial institutions and more. There are several types of Bonds for you to explore, including American, Brazilian and Latin American (LATAM) governments and companies. Check out our bonds list.
Different risk levels:
Assets classified as investment grade and high yield – more risky, but which tend to offer higher returns.
Investment professionals:
If your investor profile meets the requirements, you can count on a team of investment professionals to help you on your journey.
Bond Reports:
Constant update of free content developed by our strategists to keep you up to date with the fixed income universe.
Simplified taxes*:
We automatically generate reports for your statements, including IR and DARF (when applicable).
*Avenue Securities LLC and its affiliates do not provide legal or tax advice
Available transfers:
If you already have a Bond in your portfolio, you can centralize your bonds on a single platform by transferring them to Avenue.
- minimum investment in Bonds
The minimum investment varies depending on each Bond.
It is important to consult the details of the title to obtain more information about the application.
Ex.: US corporate bonds require a minimum of 5 units; For those from the Treasury (T-Bill and T-Note), a minimum of 10 units per investment.
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