You can think of a bond as like an IOU.
you lend your money to the company and
they agree to pay principal and interest
when they say they're going to.
so what happens in Australia when
companies get big enough
they can bypass the banks and borrow direct from investors like yourself
in contrast with a share or equity
investment, there's no obligation to pay
a dividend
and there's no maturity date with the
investment you must decide to sell
the share, to recoup your investment
investors can choose to be a banker
or an owner, and must weigh up the advantages and disadvantages of each
if you're a banker, you lend you money and
you have the known
interest repayment and principal repayment equally the company
goes into wind up
you're sitting higher in the capital
structure so you can expect to get some
if not
all of your payment returned to you, or all of your capital returned to you.
whereas with a shareholder, you're taking on much more risk
you'd expect much higher returns but
there's no guarantee
of your principle being returned to you or of dividend payments
in fact in a wind up situations
shareholders would typically be wiped
out entirely.
As a bond investor,
you're looking at the survivability of
the company. What would
cause that company to go into
liquidation, or wind up.
So you're actually looking for
diversification of income streams
the size of the company is really important
the bigger it is the better it is. So a
company, for example, like Wesfarmers,
that has varying income streams
if anyone of those suffers due to
economic climate the others will support
the company, so
it's a low risk, Wesfarmers would be a
low risk bond investment.
On the other hand, with a share or equity
investment,
you're buying that investment with the expectation of growth
but we know that growth doesn't always
happen. You're expecting the share price to grow,
and the dividends to grow, but the
share price can fall
and dividends can be cut. Did you know, for example, that during the GFC
all four major banks cut their dividends
by at least 10 percent?
As a bond investor, the only time you wouldn't
be repaid is if a company goes into
wind up, or liquidation
but companies will do just about
anything to avoid this as there are serious
consequences if they do.
Some of the measures include: a rights issue
or cutting the dividend to preserve
capital and protect the bondholders
who sit higher in the capital structure. In
summary, if you're a bond investor
you have the certainty of income and
principal being returned to you at maturity.
Now if you compare that with shares or equities, there isn't that certainty
there's not the certainty of dividends because they
can be cut or not paid at all
and there's no certainty of capital being
returned to you because you actually
have to make a decision to sell the
shares to recoup your investment.
