Checklist before buying a bond

Before placing an order for a bond, check in order: who exactly the debtor is and where your claim ranks against it; what kind of coupon the issue pays — fixed, floating or linked to indexation of the face value; whether there is amortisation, a call or a put option; what yield you get when buying at the current price and to which date it is calculated; how the issue behaves when interest rates change; whether you can exit it without losing money on the spread; and what is left after tax. Skipping any of these points is usually what explains the gap between the expected and the actual result. The platform fills in the specific values for each issue from its own database — in the cards on the Russian bonds page; this article deliberately gives no figures, because the price, the accrued interest and the yield change during the day.

Step 1. Who the debtor is and where you stand in the queue

A bond is debt, not equity. The income is set out in advance by the terms of the issue, and the only question that matters is whether the issuer will pay. So the place to start is not the yield but the legal entity named in the prospectus. Government debt (OFZ), sub-federal debt and corporate debt carry different levels of risk and different mechanisms of recovery.

With corporate debt, check who is formally borrowing: an operating company with assets and revenue, a holding company sitting above it, or a special-purpose vehicle set up for the issue. In the second and third cases look for a guarantee from the parent company — without it you are lending to an empty balance sheet. Subordinated bank issues are a separate matter: they rank below ordinary debt and can be written off or converted when a regulatory trigger is hit, without waiting for bankruptcy. Look at the issuer's financial position in its financial statements, not in the marketing presentation for the issue.

Step 2. Terms of the issue: what exactly you were promised

The type of coupon determines what you are protected against. A fixed coupon locks in the cash flow until maturity — it gains when rates fall and loses when they rise. A floating coupon (a floater) is tied to a money-market reference rate plus a constant spread: it cancels out the risk of a rate rise but deprives you of the gain from a rate fall. Issues with an indexed face value pass inflation dynamics on to you through the face value itself, not through the coupon.

Next, look in the terms for three structures that most often wreck a beginner's calculation:

• Amortisation. The face value is returned in instalments according to a schedule, not on the maturity date. The coupon accrues on the outstanding balance, so the cash flow declines over time, and you have to reinvest at a future rate that is unknown today.
• Put option. Your right to sell the bond back to the issuer early at a price agreed in advance. It is a useful right, but it requires action on your part — the application has to be submitted within the set period, otherwise the right lapses, and the coupon may be reset after the put date.
• Call option. The issuer's right to redeem the issue early. It works against you: when rates move in your favour, the issuer refinances and buys the bond back, cutting off your gain.

Step 3. Price, accrued interest and which yield you are being shown

The order book quotes the clean price — a percentage of face value. On top of that you pay the accrued interest for the days that have passed since the last coupon payment; the sum of these parts is what is actually debited from your account. Because of accrued interest, a purchase right after a payment and a purchase on the eve of the next payment look different, although their economics are close.

Tell the yields apart. The coupon yield is calculated on face value and says nothing about your trade. The current yield divides the coupon by the purchase price and ignores the return of face value. The yield to maturity takes into account the coupons, the difference between the price and face value, and the term — it is the measure that can properly be compared across issues. But for a bond with a put option you need to calculate the yield to the put date, not to maturity, and for a floater the yield to maturity means very little at all: what should be compared is the spread to the reference rate.

Step 4. Rate sensitivity and exit liquidity

The measure of interest-rate risk is duration: the higher it is, the more strongly the price reacts to a change in rates. If you are certain to hold the bond to maturity, interim mark-to-market moves do not concern you; if you may exit earlier, a long fixed coupon is a bet on falling rates, not a "safe alternative to a deposit".

Check liquidity before buying, not when selling. Look at the spread between the best bid and the best ask, the depth of the order book and how regularly trades take place. In an illiquid issue a market order is filled at the worst available price — use limit orders only. Keep the coupon and put dates in the events calendar, and look for the trigger for a repricing in the issuer's news.

Step 5. Tax, rating and the "what if they do not pay" scenario

The coupon and the income from the price difference fall into the tax base for investment transactions — the rules and the rate are filled in by the directive 13%. Compare issues by their after-tax yield and with the reliefs available to you taken into account, otherwise the comparison is skewed.

A rating from an accredited agency is not a guarantee but a compact estimate of the probability of default, and a reason to check when it was last reviewed. The high-yield segment pays a premium precisely for the risk of non-payment and for the risk of being left without a buyer in the order book. Know the procedure in advance: a missed payment results in a technical default, a full default follows once the grace period allowed for remedying it has expired, and the holders' interests in restructuring talks are represented by the bondholders' representative. If such a scenario is unacceptable to you, the right conclusion is not to buy the issue, rather than to hope.

If you would rather hold a whole portfolio than individual issues, compare the mechanics with funds, and look up unfamiliar terms from the issue documentation in the glossary. The logic of checking equity securities is built differently — it is covered in the checklist before buying a share.