For bond investors caught out by the speed and the rise of interest rates

by

With bank borrowing rates high and still creeping up, does leveraging on bonds still make sense?

In writing this, I am not defending or advocating buying bonds now. I would like to explain how I think, if I were to be caught out by the speed and the rise of interest rates.

Example.

  • An investor started out with $500k.
  • Bought $1M bonds (4x 250,000 bonds). Finance $500k from bank.
  • Average coupon rate at 4.5%
  • Assume bank financing at 5%. This is possible worst case borrowing rate.
  • Total annual coupon will 4.5% x 1M = $45,000
  • Total annual financing will 5% x $500k = $25,000
  • Profit is 45k – 25k = $20k.
  • Return of investment is 20k / 500k = 4%

Even with making the assumption of bank financing at 5%, an investor leveraging on bonds, and caught out rising interest rates, is still make decent returns at 4%.

I know that the bond prices would have dropped because of rise of interest rates, but as long as the bond investor holds to maturity, he will get back his capital at par. This cannot be applied on a unit trust bond investment, which do not have a maturity date.

  • I'm a remisier with Maybank Securities, and as a bonds and REITs investor myself, I guide my clients to build resilient bonds and REITs portfolios. If you like to be guided, please open a trading account to become my client; It's free!