Investing in Government Bonds

The price of a debt security is what the market is willing to pay for a claim on the expected future payments from that security. As with other types of securities, the price of a debt security is influenced by demand and supply, which are in general associated with factors such as prevailing market interest rates, time to maturity, degree of certainty of repayment (reflected in the credit rating),yield and overall market and economic conditions. For example, the price of a bond will typically fall when interest rates rise. Other factors affecting the overall market conditions such as inflation, exchange rates and political changes will also influence the price of a debt security.

When the price of a debt security increases above its face value, it is said to be selling at a premium. When a debt security sells below its face value, it is said to be selling at a discount.

The price of a Government Bond is affected by factors similar to other debt securities.

Currently, Government Bonds are issued in the form of conventional fixed-rate Hong Kong-dollar bonds. Investors have to be aware of the following risks of investing in Government Bonds, which are typical of those associated with bond investment generally:

Interest-rate risk: A rise in the interest rate will cause the price of a Government Bond, which is a fixed-rate bond, to decline, and vice versa. Investors should therefore be aware that if they would like to sell a Government Bond before it matures, the price at which they can sell the bond may be higher or lower than the purchase price subject to the prevailing interest rates.

Liquidity risk: Liquidity in the secondary market is often reflected in how easily an investor can purchase or sell a bond in the market. Investors should be aware that if they would like to sell their holdings of Government Bonds before maturity, they may face a risk of selling them at a price lower than the purchase price, or failing to sell the Bonds at all if liquidity in the secondary bond market is low.

In an effort to promote secondary-market liquidity, the HKSAR Government has appointed market players to be designated market makers (including Placing Banks for bonds in the Retail Tranche and Primary Dealers for bonds in the Institutional Tranche) under the GB Programme.

While Government Bonds are listed and can be traded on the Hong Kong Stock Exchange, investors have to be aware that this does not guarantee an active secondary trading market for the Bonds or that members of the public will have access to a firm bid price or a firm offer price for the bonds at a principal amount for which they may wish to purchase or sell.

Credit risk: Investors are subject to the risk of the bond issuer failing to make interest payments or repay the principal of the bonds on time. Such credit risk can be assessed by referring to the credit rating of the issuer of the bonds and the bonds themselves if available assigned by credit rating agencies based on the financial conditions of the issuer. Typically, the higher the credit rating, the greater the likelihood that the investors will receive payment of the principal and interest of the bond. Therefore, bonds with a higher credit rating generally offer a lower return. Furthermore, the price of a bond may fall in the secondary market when the credit rating of the bond or the issuer is lowered. Click here to see the current credit ratings of the HKSAR Government.

Foreign-exchange risk: For a debt security denominated in a currency other than Hong Kong dollars, investors may suffer losses due to changes in exchange rates. Government Bonds are denominated in Hong Kong dollars. Therefore, investors using their existing pool of Hong Kong-dollar funds to purchase the Bonds will not be exposed to any foreign exchange risk.

Other risks: As with all investments, returns on Government Bonds are also influenced by a combination of factors such as time to maturity, overall market conditions, and supply and demand of similar bonds. In general, risk increases with the length of maturity of bonds as the prices of longer-term bonds tend to be more sensitive to interest-rate movements than those of the shorter-term bonds. Changes in market conditions such as inflation, exchange rates, political changes and economic growth may also influence the prices of bonds.

All investments carry risks and Government Bonds are no exception. Investors are advised to ensure they fully understand the risks associated with holding Government Bonds before making their investment decisions. They should seek independent professional advice from a financial consultant, professional accountant or other professional advisers as appropriate.

Like any conventional bonds, the total return on a Hong Kong-dollar Government Bond is measured by the yield to maturity, not the coupon rate. Yields depend on the sum of interest payments (coupons), principal amount receivable upon maturity, time to maturity, and the purchase or subscription price. In general, the longer the time to maturity of a bond and the lower the credit rating of the bond issuer, the higher the yield to maturity. See Question 4 to learn how to calculate the return on bonds and Question 5 to learn about the distinction between yield and coupon rate.

The yield, quoted by banks or securities brokers, is the "yield to maturity", which represents the annual rate of return, expressed as a percentage, if the bond is held to the maturity date. The calculation is based on the annual coupon payment, time to maturity, the par value and the purchase or subscription price. It assumes that coupon interest rate paid over the remaining tenor of the bond is re-invested at the same rate as the "yield to maturity".

For example, you buy a Government Bond with a remaining maturity of one year at a price of HK$99 (per HK$100 face value of the Government Bond). It has an annual coupon rate of 0.5%. The total return for this one year includes capital gain of HK$1 and interest income of HK$0.5. The yield to maturity of the Government Bond is therefore (1+0.5)/99 = 1.5%.

The coupon rate on a Government Bond is set when the Government Bond is first issued by the HKSAR Government, and remains fixed throughout the tenor of the Government Bond. Interest payable to the bondholder is calculated based on the coupon rate. In contrast, the yield to maturity on the bond will vary with the bond's time to maturity and its market price, which in turn depends on a number of risk factors as discussed in Question 1 above.

Investors should therefore be aware that the specified coupon rate may be different from the bond yield, which in general moves in the opposite direction to the bond price. Specifically, if you buy a bond at par, then the yield to maturity is the same as the coupon rate. When you buy a bond above par (i.e. at a premium), the yield to maturity is lower than the coupon rate. Likewise, when you buy a bond below par (i.e. at a discount), the yield to maturity is higher than the coupon rate.

Investors may refer to the Government Bonds Fixings for the prevailing market prices and yields of all issues of Government Bonds. Investors can also visit the CMU Bond Price Bulletin at https://www.cmu.org.hk which makes available the prices of some Government bond issues. Investors can also make an enquiry to any of the Placing Banks under the GB Programme for the latest market prices and yields. For historical reference yields, please click here.

The current market value of a bond can be calculated by multiplying the nominal amount (the face value) by the latest available clean price divided by 100, and then add back accrued interest. Go to Question 8 to learn more.

Current market value = nominal amount x (clean price/100) + accrued interest

Accrued interest is the interest earned by the seller from holding the bond from the last interest payment date until the disposal date. By convention, the Government Bonds are bought and sold at a quoted clean price, which is exclusive of accrued interest. A buyer of Government Bonds has to pay to the seller the purchase price plus an amount equal to the interest accrued from the last interest payment date to the settlement date.

Government Bonds are issued in computerised book entry form only. Investors can only hold the Government Bonds through a Recognized Dealer's securities account with the HKMA. A custody fee is the fee charged by the Recognized Dealer for providing the safe custody service. Investors should familiarise themselves with the charging scheme of a Recognized Dealer before subscribing to its service.