Risks reflected in bond offer
THE index continued to outperform the overall UK market last month, thanks mainly to the continued share price strength of its two biggest constituents, St Modwen Properties and Dechra Pharmaceuticals.
There were also good moves seen at Goodwin and NWF, though neither company released any new information or updates to investors.
St Modwen launched its first corporate bond issue in October.
A bond is one of the four cornerstones of investment and the word is often used to describe various financial products, but a true bond is a debt instrument which promises to repay the buyer a fixed amount on a fixed date, with a fixed rate of interest payments during the period.
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So, St Modwen's bonds will cost £1 each to buy and St Modwen will pay the buyer an annual interest rate of 6.25 per cent until November 7, 2019, when the bonds will be repaid at £1 each.
The investor gets a rate of interest on their money, and St Modwen gets the cash to use in its business until the repayment date, a mutually convenient arrangement.
The first bond was issued by the Bank of England in 1693 to raise money for the UK government to fund a war against France. Now, of course, all governments help fund their activities by issuing bonds to investors.
This all sounds fine but in order for the investor to get their return, they must be sure that the issuer can afford to pay the interest and eventually pay his money back. The UK government has never defaulted on its debt, and neither has the U.S. government. This is why their bonds are classed as risk-free.
Developed countries, such as ours and America, can always raise more money from taxing us to help pay off their debts. Other so-called risk-free bonds include countries with sound finances, such as Switzerland and Germany.
However, history is littered with governments which have been unable to repay their debts in full. The most recent example is Greece, where investors recently only got paid around 30p for every £1 of debt they owned.
Russia defaulted on all its debts after the Revolution in 1917, and many countries in Latin America have very poor records as well.
All this matters when it comes to interest rates. For example, if you buy short dated UK or German government bonds at present, after tax you actually make a small loss.
Some investors remain fearful and so they are prepared to buy bonds which give them no return at all, indeed a small loss, as long as they think their capital is safe. If you are a big investor with millions of pounds, you cannot simply deposit it in the bank or building society since, if things go wrong, only £85,000 is guaranteed and we have seen in recent times how close to collapse banks can come.
A well-financed multinational company, like BMW, can raise money by issuing bonds paying only around two per cent because investors believe the risk of default is low.
St Modwen has to offer a higher rate of 6.25 per cent to attract investors because it is a much smaller company and investors perceive the risk to be greater. As ever in investment, a higher risk should offer a potentially higher reward.