Currently, the base interest rate in the United States is 4.75-5.00%, and the base rate in Korea is 3.50%. But what was the interest rate before corona? It was 1.00~1.25% in the United States and 1.25% in Korea. The zero interest rate continued in the corona pandemic city, and the rally of the interest rate increase took place last year.
Even if you make this comparison, you can see that the current interest rate level is quite high. It is questionable how long this high interest rate situation can last.
Indeed, experts believe the rate hike cycle is nearing its end. It is anticipated that interest rates will be cut in the middle of next year or at the end of this year at the earliest.
Bonds are a promising investment target before a period of falling interest rates. For ordinary investors, bond investing is still unfamiliar and difficult. This time, we will present what you need to know before investing in bonds and the bond-related investment products that have emerged recently.
Why do bond prices rise when interest rates fall?
A bond is a type of IOU. It can be said that it is a written document that says when you borrow money from the country or a company, you will pay back the principal and how much interest you will pay.
Deposits only receive a certain amount of interest and principal when they mature. Bonds usually pay interest every three months. And you can sell mid-term rather than holding to maturity. If the deposit is canceled midway, the principal is paid as it is, but the interest is not paid in full. Bonds do not. Investors who buy new bonds will pay interest in the future.
When you sell a bond before maturity, if the interest rate is higher than when you bought the bond, the value of the bond you hold falls, and if interest rates fall, the value of the bond rises. The interest rate on the bond I have is the same, but I know what a bond investment is when I know the price of the bond goes up and down.
Immediately after the pandemic, the 10-year US Treasury yield was just 0.5%. Now that prices are rising by about 6% a year, anyone holding these bonds is effectively losing money. Currently, the new 10-year US Treasury yield is 3.60%. Anyone looking at US Treasury bonds that yield 0.5%? If the principal is 10,000 won, you will have to bid it at a price of 10,000 won or less.
Let’s calculate more precisely. Assume a bond with a principal of 100 million earned, a maturity of 3 years, and an interest rate of 10%. When the market interest rate is 3%, the price of this bond is 119.78 million won. The market interest rate of 3% means that the value of the currency falls by 3% every year. The price of this bond is calculated by inverting the interest that comes out over three years and the principal that comes out at maturity, reflecting the market interest rate of 3%.
However, when the market interest rate rises to 5%, the bond price falls to 113.61 million won, and when it rises to 7%, it falls to 107.86 million won. As you can see, the bond’s coupon rate is constant, but the bond’s price falls as the market interest rate rises.
This story is based on the premise of selling before maturity. If you hold it to maturity, you don’t have to worry about the price of the bond. You can earn interest every three months and get the principal back at maturity.
Not all bonds are the same … Flow-flow relationship between risk and return
If you are asking how to buy bonds, I would recommend a bond ETF. In terms of accessibility, ETF bond investments are superior to direct bond investments in that they can be traded easily and conveniently with small amounts, and are superior to bond funds in terms of fees. Although it is an indirect investment, if you buy a bond ETF, certain interest comes in under the distribution name for a certain period.
If you look for a bond ETF on the securities tab of portal websites or MTS (Mobile Trading System), there are many different types. You may be hesitant to choose between the two.
Basically, you can see that the interest rate is determined by how much risk you are willing to take.
Where the bond was issued, from the investor’s point of view, you should first look at the debtor’s credit rating. A credit score is a score by which the credit rating agency looks at the debtor’s condition and states ‘I think I will pay the money well’ and ‘It is dangerous here’.
There are slight differences, but usually in the order AAA, AA, A, BBB, BB, B, CSC, etc. Countries, public corporations, banks, local governments, etc. are mostly AAA or AA. Although interest rates are low, stability is the best. You can search for ‘government bonds’ or ‘government bonds’ in the ETF search box.
In terms of interest rates, corporate bonds of A or higher are usually recommended. The interest rate comes out to some extent, and it is not a company that will be ruined immediately. If you are looking for an ETF that mixes government bonds and corporate bonds, you can look for a composite bond ETF.
Bonds below BBB are considered junk bonds and belong to a high risk group. Since it’s a niche domain, I don’t want to recommend it to bonding beginners.
Maturity is also important. This is because there is a big difference between paying the money back in 10 years and paying it right next year. Even if they are issued in the same place, long-term bonds naturally have higher interest rates. This is because long-term bonds are riskier.
In addition, long-term bonds with a maturity of 10 years are more volatile than short-term bonds of 1-2 years. This means that the price of long-term bonds will rise more than short-term bonds at a time when interest rates are expected to fall and bond prices are expected to rise, as they are now. If you think interest rates will fall in the medium to long term, investing in long-term bonds is the way to go.
Reasons to buy Samsung Electronics ETFs instead of Samsung Electronics
Bonds are so hot these days that different types of bond ETFs are also popping up.
First of all, the bond ETF I want to introduce is a ‘single stock ETF’. Single stock here refers to one stock. It is a hybrid ETF that contains a mix of stocks and bonds. Invest around 30% in stocks and 70% in bonds.
Currently, there are four single stock ETFs listed, each consisting of Samsung Electronics, Apple, Tesla, and Nvidia. It is a method of investing in stocks that are promising in the long term, such as Samsung Electronics, and bonds in nine or more stocks, such as government bonds and corporate bonds.
There is an advantage to being able to allocate assets with a single ETF. It can be said that it is a customized investment product for investors who want to buy only Samsung Electronics or Tesla among stocks while protecting the rate of return by investing mainly in stable bonds.
There are also bond ETFs that are similar to deposits. At least, it’s perfect for investors who don’t want to see a loss.
The ETF ‘TIGER 24-04 Corporate Bond (A+ or higher) Active’ is an ETF with a maturity date of April 2024. It is an ETF with a fixed maturity. If interest rates fall before maturity and bond prices rise, you can sell the ETF to make a profit. Conversely, when interest rates rise and bond prices fall, you hold them until they mature. If you hold it until maturity, you will earn around 4% per year. These ETFs are called maturity-matched bond ETFs.
Of course, since a maturity-matched bond ETF consists mainly of corporate bonds, you should consider the risk of the company going bankrupt. Still, I think it’s worth paying attention to as it guarantees a fixed interest rate slightly higher than the deposit rate and it’s possible to cash out before maturity.
