Risk Disclosure Statement for Trading Bonds
Tiger Brokers (NZ) Limited (“TBNZ”) is providing this document to you to provide some basic facts about trading bonds (including but not limited to U.S. Government Bonds/Treasuries, Municipal Bonds, Corporate Bonds, etc.), and to alert you to the risks involved in trading bonds through TBNZ.
1. Characteristics of Bonds
1.1 What is a bond?
Bond, issued by a corporation, government, federal agency or other organization to raise capital, is a common type of debt security in which the borrower/issuer agrees to pay interests (if applicable) to the lender/investor over a specified term plus repayment of bond’s face value/par value at the bond’s maturity date, in exchange for the capital raised.
1.2 What are the types of bonds?
Some of the bonds commonly traded by investors include:
a. U.S. Government Bonds
Bonds issued by the U.S. government are called Treasuries. These are grouped into three categories: (1) Treasury bills; (2) Treasury notes; and (3) Treasury bonds. They each have a different length of time until maturity. Treasuries are considered relatively safe bond investments since the U.S. government backs them and it is highly unlikely that a situation of default will occur. However, Treasuries with longer maturities generally have higher interest rate and credit risk.
b. Municipal Bonds
Municipal bonds are debt obligations of state or local governments. The funds raised may be used to support general governmental needs or special projects. Municipal bonds are considered riskier investments than Treasuries. Municipal bonds often pay a lower interest rate because of their favorable tax treatment. When considering an investment in municipal bonds, bear in mind that no two municipal bonds issues are exactly alike, so it is important to carefully evaluate up-to-date information about both the bond and its issuer.
c. Corporate Bonds
Companies issue corporate bonds to raise money for capital expenditures, operations and acquisitions. There are many types of corporate bonds, and investors have a wide range of choices with respect to bond structures, coupon rates, maturity dates and credit quality, among other characteristics.
Corporate bonds tend to be categorized as either investment grade or non-investment grade. Non-investment grade bonds are also referred to as "high yield" bonds because they tend to pay higher yields than Treasuries and investment-grade corporate bonds. However, with this higher yield always comes a higher level of risk. High yield bonds also go by another name: junk bonds.
Most corporate bonds are traded in the over-the-counter (OTC) market. The OTC market for corporates is decentralized, with bond dealers and brokers trading with each other around the country over the phone or electronically.
Convertible Bonds are bonds that may be converted into another form of corporate securities, usually shares of common stock. Conversion only occurs at specific times at specific prices under specific conditions and this will all be detailed at the time the bond is issued.
d. Zero-Coupon Bonds
These are bonds that do not pay interest periodically, but instead pay a lump sum of the principal and interest at maturity. Investors, however, may need to pay taxes on the interest as it accrues, not when they receive it.
e. Sovereign Bonds
A sovereign bond is a specific debt instrument issued by a government (usually outside of the United States). They can be denominated in multiple currencies. Similar to other bonds, these generally pay the buyer a certain amount of interest for a stipulated number of years and repay the face value on maturity.
1.3 How are Bonds Rated?
There are several rating agencies in the market, such as Standard & Poor's Global Ratings, Moody's and Fitch Ratings, that make evaluations of bonds and their issuers, and assign credit ratings to them. The ratings for bonds reflect mainly their default risks and are subject to change by factors that affect their issuer’s credit. The ratings that appear for the bonds TBNZ offers are from sources TBNZ believes to be reliable; however, TBNZ cannot guarantee their accuracy.
2. General Risks of Bond Trading
Trading in bonds may not be suitable for all investors. Although bonds are often thought to be conservative investments, there are still numerous risks involved in bond trading. Before trading bonds, you shall consider consulting a financial advisor, who can provide advice on whether particular investments suit your financial goals.
2.1 Credit & Issuer Risk
When you invest in a bond, you are lending money to the issuer. If the issuer of the bond defaults, is bankrupt or is otherwise unable to pay its obligations as they come due, you may lose some or all of your investment. TBNZ is not obliged to claim the losses for the investors resulting from the issuer’s default/bankruptcy, although it may choose to provide certain assistance, and investors shall be fully aware of and accept the credit & issuer risks before investing in any bonds.
2.2 Market risk
The prices of bonds may rise and fall, and may be susceptible to adverse economic, market, or political events and occurrences, global or regional events such as war, acts of terrorism, the spread of infectious illness or other public health issues, recessions, etc.
2.3 Prepayment risk
Prepayment or “call” risk involves the scenario where an issuer “calls” a bond. If this happens, your investment will be paid back early and you may not be able to locate an alternative bond with similar terms. Certain bonds are callable and others are not, and this information is detailed in the prospectus. If a bond is callable, the prospectus will detail a “yield-to-call” figure. Corporations may call their bonds when interest rates fall below current bond rates, which will allow them to re-borrow at a more beneficial rate.
A “put” provision allows a bondholder to redeem a bond at par value before it matures. Investors may do this when interest rates are rising and they can get higher rates elsewhere. The issuer will generally assign specific dates for bondholders to take advantage of a put provision. Prepayment risk is often figured into the pricing of bonds.
2.4 Inflation Risk
Inflation risk is the risk that the rate of the yield to call or maturity of the bond will not provide a positive return over the rate of inflation for the period of the investment. For example, if the rate of inflation for the period of an investment is six percent and the yield to maturity of a bond is four percent, you will receive more money in interest and principal than you invested, but the value of that money returned is actually less than what was originally invested in the bond. As the inflation rate rises, the interest rates often rise. Although the yield on the bond may increase, the price of the actual bond may decrease.
2.5 Interest Rate Risk
Interest rate risk is the potential for investment losses that result from a change in interest rates. If interest rates rise, for instance, the value of a bond or other fixed-income investment always decline.
2.6 Liquidity Risk
Liquidity risk is the risk that you will not be easily able to find a buyer for a bond you need to sell. If there is a limited or no secondary market for bonds you hold, the sale price may be much lower than the amount invested or the amount you may receive if you hold the bond to maturity.
3. Risks of Trading Bonds Electronically
TBNZ is an online, execution-only brokerage firm that executes your orders as agent and may further engage the agent of another broker or subsidiary to execute your orders. TBNZ will post bids and offers for bonds from various information sources and markets and will allow you to execute trades against those electronically-displayed bond quotes. Unlike the practice of many other brokers, TBNZ typically does not make telephone calls to various bond dealers in seeking to execute your bond orders. Rather, TBNZ will route your orders to other electronic bond trading platforms.
Electronic trading has a number of inherent advantages (such as speed, low cost, and a clear audit trail) but it also has certain inherent disadvantages. You should be aware that electronic bond trading platforms may have less liquidity or less advantageous prices than could be offered telephonically by a bond dealer. In addition, electronic trading platforms are inherently vulnerable to technical errors and outages.
Please note that many bond dealers place quotes to buy or sell the same bond position on multiple bond trading venues (e.g., 10 bonds on Market A and 10 bonds on Market B). If your order executes against both of the quotes (e.g., an order to buy 20 is filled 10 at Market A and 10 at Market B), the dealer may request that one of the trades be busted (reversed). TBNZ reserves the right to grant such requests without your consent if TBNZ, in its discretion, believes that the dealer is acting in good faith.
4. Risks Specific to Distressed Bonds
Distressed bonds generally are bonds of an issuer which has either defaulted, is under bankruptcy protection, or is in financial distress and moving toward bankruptcy or default in the near future. Distressed bonds frequently trade “flat,” meaning that the buyer of the bond is not responsible for paying the interest that has accrued since the last payment. In effect, a flat bond is a bond that is trading without the accrued interest. The price of a flat bond is referred to as the “flat price” or “clean price.” Typically, flat prices are quoted so as not to misrepresent the daily increase in the dirty price (bond price plus accrued interest) since accrued interest does not change the yield to maturity (YTM) of the bond.
On the Settlement Date, the buyer must pay to seller only the agreed upon price, without any payment in respect of interest. The person holding the bond on the Record Date receives any and all interest payments whenever made. If a Record Date occurs before the Settlement Date, seller will get any interest paid on a bond that is trading Flat. If there is a change in the Record Date, the party that was a bondholder with respect to the prior Record Date loses any rights they may have had to receive any related payment of principal or interest.
If a bond that was sold with accrued interest begins trading Flat after the trade date, but before Settlement date, the buyer remains responsible for paying the accrued interest to the seller, even though the buyer may not receive interest from the bond issuer. If the accrued interest payment is not made on the actual Payment Date, but is made during the Grace Period, any interest payments will accrue to the seller. If accrued interest is paid after the Grace Period, it will belong to the buyer when paid.
Bankruptcy courts can issue broad orders at the request of a bankruptcy debtor that halt or seriously restrict trading in all of the debt and equity of the debtor corporation for the protection of the bankruptcy debtor's net operating loss ("NOL") carryovers and other tax attributes of the debtor.
"Minimum denomination transfer requirements" are generally found in the Indenture and the offering documents and provide that a transfer of a bond whether in physical or book- entry form be made in certain minimum denominations.
Clients should be aware that bonds may begin trading flat before a legal default occurs. In this scenario, brokers anticipate the default occurring and the market and dealers will trade bonds without Accrued Interest even though the issuer has not missed an interest payment.
5. Risks of Utilizing the Trading Desk
Clients that utilize the TBNZ’s trading desk to trade bonds should be aware of the risks inherent with trading bonds in the non-electronic manner. When the trading desk agrees to work a client’s order, we are only indicating a willingness to attempt to place the order requested by the client and are not obliged to enter into any transaction or guaranteeing the full or partial execution of such order.
TBNZ’s trading desk may exercise their discretion in deciding whether to work the order, which orders we are willing to execute and when and how to execute all or any part of an order. When TBNZ agrees to work an order over a period of time or otherwise to accept an order involving the exercise of discretion, TBNZ will attempt to exercise this discretion reasonably and fairly, but, unless otherwise agreed, TBNZ is not committed to executing all or any part of the order in any particular way.
This Risk Disclosure Statement is for reference purposes only and is neither an offer nor a solicitation to purchase or sell any financial product or service. None of the information provided in this Risk Disclosure Statement constitutes a recommendation that any product or service is suitable for any person. This Risk Disclosure Statement does not purport to disclose or discuss all of the risks and other significant aspects of any transaction. In light of the risks, you should undertake such transactions only if you understand the nature of the above financial products, the contracts that you are entering into, and the extent of your exposure to risk. You should therefore consult with your own legal, tax, and financial advisers before entering into any particular transaction.
This Risk Disclosure Statement is written in English and Chinese languages. In the event of any discrepancy or inconsistency, the English version shall prevail.