How to Invest in Australian Government Bonds (AGBs) and The Basics of Australian Government Bonds
The Basics of Australian Government Bonds
Let’s talk about Australian government bonds, which are like essential support and protection for your investment portfolio. Bonds function like IOUs from the Australian government, promising investors interest payments until a specified future date when they receive their original investment back. Here are some key terms to understand:
- Face Value: The original cost of the bond and the amount the bondholder receives at maturity. Australian government bonds have a face value of $100.
- Coupon: The interest payment received by the bondholder, expressed as a percentage of the face value. It is paid twice a year.
- Maturity: The length of time between the bond’s issuance and the date when the bondholder receives the face value from the government. Short-term bonds have a maturity of 1 to 3 years, while long-term bonds have a maturity of 10 years or more.
- Yield: The bond yield compares the coupon rate to the current market price of the bond. It represents the percentage return on the bond.
Why Bonds Are Essential in Your Portfolio
Bonds are considered a risk-free investment and act as a benchmark for evaluating other investments. They provide stability and help reduce the volatility of your portfolio. In times when stocks perform poorly, bonds tend to do well. Diversifying your assets into both stocks and bonds can cover all your bases and reduce portfolio volatility.
How to Buy Australian Government Bonds Easily
To buy Australian government bonds, you can either purchase them directly from the government through the primary bond market (available to banks, super funds, and institutional investors) or buy them from other investors on the secondary market, such as the ASX.
On the ASX website, you can find a list of currently tradeable government bonds. Simply go to www.asx.com.au, click on “Markets,” then “Cash Market Prices,” and scroll down to “Bonds.” Here, you will find information on different bonds, including market price, coupon rate, maturity date, and the date of the next coupon payment.
The government. If you wanted to buy this bond, all you would need to do is type the 6-letter ticker symbol into your favorite brokerage platform and you are good to go. How do I work out which bond to buy? When you look at the bonds on the ASX table, it can be a little bit confusing. There are cheap bonds, expensive bonds, bonds with high coupon rates and low coupon rates, and bonds with vastly different maturity dates. If you want to properly compare these bonds against each other, you’ll need to calculate something called yield to maturity. This calculation measures the yield of the bond if it is held to maturity, and takes into account any capital gain or loss due to the difference between the price you paid for the bond and the bond’s face value. Since yield to maturity is a complex mathematical calculation, you’ll need to use a special calculator. Omnicalculator has one which I’ll link for you in the description below.
If you wanted to calculate the yield to maturity of the gsbg27 bond that we looked at earlier, we would just put in the face value, which is $100, the bond price, which is $107.19, the coupon rate, which is 4.75%. AGB payments are all semiannual, and there will be 4 years until the bond matures. The yield to maturity for this bond is 2.84%, which is much lower than the coupon rate of 4.75%.
This is due to two reasons. Firstly, the higher purchase price results in a lower yield, since $4.75 as a proportion of the $107 purchase price is only 4.4%. Secondly, we will have a capital loss when the bond matures, since we will only get back the face value of $100, which is $7.19 less than what we had initially paid for it. What I typically do to compare bonds is calculate the yield to maturity of every available bond and put it all in a spreadsheet to work out which one I want to buy.
Why do bond prices move up and down? The short answer is interest rates. When interest rates are rising, the government will issue new bonds with a higher coupon rate. This makes existing bonds in the market that have a lower coupon rate less desirable and so they will automatically get cheaper until their yields match that of the newly created bond. For example, an old bond with a 2% coupon is not as good as a new bond with a 4.75% coupon, but market forces will quickly push the price of the 2% bond down to around $90, where the yield to maturity of both options will be very similar. According to the same logic, if interest rates are dropping, the government will issue new bonds with a lower coupon rate.
This makes existing bonds in the market that have a higher coupon rate more desirable, which pushes up their market price and lowers their yield until they match that of the newly created bond. Furthermore, as a bond approaches its date of maturity, its price will trend towards an amount equal to the face value plus the final coupon payment. So whatever happens to the price of gsbg27 over the next few years, the price of the bond will be $100 plus half of $4.75, which is $102.37 as we approach April 2027.
At the end of the day, the fluctuations in the price of your bonds are not so critical if you intend to hold your bond until maturity. The market value of the bond might change, but if you never sell it, you will simply receive your regular coupon payments as well as the face value of the bond when it matures.
Can I use bonds to protect myself against inflation? So far, we’ve only talked about vanilla bonds, but there is another type of bond which can protect you against inflation, called Treasury Indexed Bonds or TIBs. While a vanilla bond will always have a face value of $100, a TIB has a face value of $100 + CPI, which is adjusted every quarter. Increasing the face value of the TIB also increases the underlying coupon payment, since the coupon rate is a percentage of face value. When the TIB eventually matures, it will be redeemed for whatever the adjusted face value is on the date of maturity. This is great because you will be completely protected against inflation. The drawback of TIBs is that their coupon rates will typically be a little bit lower.
The ASX website lists tradeable TIBs on the same page as vanilla bonds. You just need to click the “Exchange-Traded Treasury Indexed Bond” tab and scroll down to see the list. The ASX also releases quarterly announcements which outline the adjusted face values of tradeable TIBs. Simply type the TIB’s ticker symbol into the search box and go into the summary page for the bond. Scroll until you see “Announcements” and click “Interest Details” to open the document. This