Investing in bonds can be a helpful way to manage your wealth, and if you want to make the most out of it, you will need to know how trading works. The notes and coins we use every day and savings accounts held with banks represent different types of debt: these debts are known as bonds.
Debt is used by governments to help finance activities such as building roads, education or war. In return for money received from the sale of bonds, the issuer agrees to pay back the loan with interest after some time has elapsed. When an issuer fails to repay the amount borrowed in full on time, this event is known as a default.
Traditionally, when an investor wanted to buy a bond, they would go through a broker to find the best deal for them. However, since the advent of electronic trading, this process has become much more accessible, and investors can now trade bonds directly.
There are two main ways to trade bonds
It’s where two parties agree on a price and then trades directly with each other.
Exchange-traded fund (ETF)
An ETF is a security that tracks an index, a basket of assets, or a commodity. When you invest in an ETF, you are buying into a fund that holds investments such as stocks, bonds and commodities. ETFs can be bought and sold all day on exchanges, just like regular stocks.
When you trade ETFs, you invest in companies with underlying assets such as bonds. There are three types of bond ETFs: government bond index funds, corporate bond index funds and mortgage-backed security (MBS) funds. Government bond ETFs track the prices of Treasury bills, notes and bonds; corporate bond ETFs hold investment-grade debt securities issued by corporations, and MBS funds invest in fixed income instruments backed by mortgages or other debts.
When an investor wants to buy a particular company’s stock within an ETF investment, they can place an order on their broker’s platform, which will be matched with another who is willing to sell theirs at the same time.
The price of a bond ETF is determined by the value of the underlying assets and can rise or fall depending on market conditions.
When trading ETFs, you will need to be aware of the following:
- The bid/ask spread – This is the difference between the highest price someone is willing to pay for an ETF (the bid) and the lowest price someone is willing to sell it for (the ask).
- The net asset value (NAV) is the total value of all the assets held by an ETF divided by the number of outstanding shares. It changes throughout the day as the prices of the underlying assets fluctuate.
- Premiums/discounts – If an ETF’s share price is higher than its NAV, it is said to be trading at a premium, and if it is lower, it is trading at a discount.
When trading ETFs, you will need to keep an eye on the news and make sure you are aware of any events that could affect the prices of the underlying assets. For example, if there is bad news about a particular company with bonds within an ETF, the share price could fall as investors sell their holdings.
Trading ETFs can be a great way to get exposure to different types of bonds, and by doing your research, you can find funds that offer the best returns for your investment goals. By following the tips above, you will trade ETFs like a pro! If you’re new to trading altogether, it’s highly advisable that you reach out to a reputable brokerage for expert advice on the safest way to start trading. Using a demo account is another sure way of minimising your initial risk.