Bond trading is the buying and selling of bonds on the secondary market. The Australian bond market is a wholesale market where participants trade bonds online directly with each other rather than through a stock exchange.
Most trading in Australian government bonds occurs via electronic trading platforms. The two largest platforms are the ASX 24 platform operated by the Australian Securities Exchange (ASX) and Bloomberg’s Tradebook platform.
Government bonds are typically traded in large denominations, known as “round lots”. A round lot of Commonwealth Government Bonds (CGBs) has a $100,000 face value, while a round lot of state government bonds (SGBs) has a $50,000 face value.
Regarding bond trading, Australia has several procedures that help ensure the process is conducted smoothly and efficiently.
A licensed broker must check all trades to ensure that their client has the required margin and that the trade is within their risk limits.
The order is then sent to the trading desk, which matches it with another order from another client or the market maker.
Clearing and settlement
Once a trade has been executed, it will go through a clearing and settlement process. This process can take up to two days for government bonds.
Traders must report all trades to the Australian Securities and Investments Commission (ASIC) within 10 minutes of execution.
If the value of a client’s portfolio falls below the required margin, the broker will make a margin call and require the client to deposit more funds or securities.
All trades are settled, and the client is debited or credited for any trades executed during the day.
Once a trade has been settled, the securities are delivered to the buyer’s account.
Clients who want to hold a position overnight will need to roll over their trade. It involves closing the current position and opening a new one for the next day. The broker will charge a small fee for this service.
Benefits of trading bonds in Australia
Here is a look at some benefits of bond trading.
Access to a large and liquid market
The Australian bond market is one of the world’s largest and most liquid markets, which means there is always a buyer or seller for any given security, and prices are very stable.
Low transaction costs
Transaction costs in the Australian bond market are meagre. It is due to the high competition among brokers and electronic trading platforms.
Bond investors have a great deal of flexibility when investing in bonds. Different types of bonds are available, with different maturities, coupons, and yields.
The Australian bond market is efficient, which means that prices are always fair and reflect all available information.
Safe and secure
Bonds are a safe and secure investment because they are backed by the full faith and credit of the issuing government, which means they will never default on their payments.
Bonds are a tax-advantaged investment. The interest payments on bonds are exempt from personal income tax.
Traders can use bonds to diversify a portfolio, and they have a low correlation with other asset classes, which means they can help to reduce risk.
Disadvantages of bond trading
Here is a look at some disadvantages of bond trading.
Interest rate risk
Bond prices are delicate in terms of interest rate changes. When interest rates rise, bond prices fall, and vice versa.
Credit risk is the risk that the bond issuer will default on their payments. This risk is higher for bonds with lower credit ratings.
Liquidity risk is the risk that a bondholder will not be able to sell their bond at a fair price. It can happen if there are not enough buyers in the market.
Inflation risk is the risk that the value of a bond’s payments will be eroded by inflation. It is a greater risk for bonds with longer maturities.
Market risk is the risk that the bond market will experience a sudden and sharp decline. It can happen for various reasons, such as a change in interest rates or economic conditions.