Bond market vs stock market: which market to choose

The stock market is an institution or mechanism that brings together buyers and sellers of stock prices, that is, securities. In the securities market, relations arise between its participants regarding to the issue, circulation, and redemption of securities. The securities market is part of the financial market. The main objective of the securities market is the accumulation of temporarily free cash for investment. Distinguish between organized (exchange) and unorganized (over-the-counter) securities market, as well as primary and secondary stock markets.

How to get involved

To participate in trading on the stocks and bonds exchange, an ordinary legal entity or individual must enter into a commission agreement with a broker. Transactions in the OTC market are carried out by concluding agreements with mandatory registration with a professional participant in the securities market. The primary stock market plays an essential role in the country’s market economy. The pace of its development and effectiveness largely depend on it. It contains securities issued for the first time. In the secondary stock market, previously issued securities are resold to other investors. The structure of the stock market consists of the following components:

  • securities market participants (buyers and sellers);
  • market infrastructure (exchange, brokers, depositories);
  • securities market regulatory authorities (Securities Department, other organizations);

Securities are divided into the following groups:

  • Shared. The equity security secures the owner’s rights to part of the property of the enterprise during its liquidation, confirms the owner’s participation in the formation of the authorized capital, gives the right to receive part of the profit and to participate in the management of the enterprise;
  • Debit. Debt security reflects the relationship of a loan between its owner and issuer, which agrees to redeem it at a specified time and pay a certain percentage.

The classification of types of securities by major issuers is as follows:

  • government securities issued by the Ministry of Finance of the Republic of Belarus on behalf of the Republic of Belarus;
  • corporate securities issued by private businesses.

Securities may be registered or bearer, issued in documentary or non-documentary form. There are other classifications of securities on various grounds.

What is the derivatives market

The bond market is a market of derivative instruments (derivatives): options and futures. Here they trade in contracts for essential assets – stocks and bonds, currencies, goods, real estate, reasonable interest rates, fixed income. The buyer of the contract can receive the asset at a fixed price within a few months.

Here’s how it works: in June 2019, you agree to buy ten shares of Company X at 220 rubles apiece until September 2019. And at the same time pay part of the amount that guarantees your intentions. If in September the value of the shares rises to 250 rubles, you can buy them at a fixed price earlier and sell them at a new one. Then with one share, you will earn 30 rubles, and with ten – 300 rubles.

In our example, the guarantee coverage is approximately 10%, but this figure may vary depending on the volatility of the asset. It turns out that to purchase a 2,200 ruble contract, you need to provide only 220 rubles.

How the price of contracts is formed

The fair price, which suits both the seller and the buyer, directly depends on the cost of the underlying asset. That is, the value of the contract for ten shares will depend on the amount of ten stocks.

The value of money, or the risk-free interest rate, for the duration of the contract, the payment of dividends to shareholders (usually the shares fall by the number of dividends paid) is included in the value of the contract. And commodity contracts are traded more at the cost of storing the goods to compensate for such expenses to the holder of the underlying asset.

Differences between the derivatives market and the stock market

The stock market is less risky, suitable for those who want to capitalize on significant price changes, dividends, and coupon bonds. The derivatives market is often used for speculation. Here, for the transaction, only the amount of guarantee collateral is sufficient, and the possible profit or loss of the position is higher than in the stock market. Also, the derivatives market allows you to insure risks. Imagine that you are going to go abroad in 3 months. A trip will require about €5,000, but now there are no such funds. The euro is at a minimum, and further growth is expected. You can conclude a contract for the purchase of the required amount, giving 10% as a guarantee. So you get a guarantee that during the term of the contract you can buy €5,000 without losing on exchange differences. And even if the euro grows by 20%, you will be able to compensate for losses from the growth of the futures rate.

Entry thresholds, asset acquisition, and trading days in markets

The bond market has a low entry threshold. Commissions for trading here are less than in the stock market, and the small amount of guarantee coverage allows you to start trading with only a few thousand rubles. When trading on the stock market, the buyer becomes the owner of the asset until it is sold, and on the derivatives market, it merely fixes the purchase price for several months.

Another bond market has a more extended trading day, which allows you to respond to events after the stock market closes. The trading day lasts from 10:00 to 23:50. From 14:00 to 14:05 and from 18:45 to 19:00, trading stops for the clearing session – at this moment the results of the last session are calculated after which your guarantee coverage increases or decreases.

How to trade in the derivatives market

You can get access to bond market instruments at a broker. As in the stock market, you need to install a standard trading terminal or a particular application. The privacy policy allows participants to be confident in the security of their data.

Derivatives market instruments

The name of the contract looks something like this – SBRF-6.19. The letters correspond to the name of the asset – Sberbank shares, then comes the month of execution – June, and later the year – 2019. Futures are of two types – deliverable and settlement. The former involves the receipt of an asset after the expiration of the contract, and the latter means the revenue of profit or loss from price changes.

When purchasing a staged futures contract, the buyer agrees to buy back the underlying asset from the seller at the end of the contract. Since this obligation, neither the seller nor the buyer can refuse to fulfill the contract, ahead of schedule, you can only conclude the opposite transaction to close the position. When using settlement futures, after the expiration of the agreement, the amount on the accounts of the buyer and seller changes. If the value of the futures has risen, the buyer receives the difference between the final and initial price, and the seller loses this difference. Options differ in that they do not oblige, but allow you to buy an asset at a set price during the term of the contract. For such a right, the buyer pays a premium, unlike guarantee coverage, it is not refundable.

Market Development Statistics

In the past two years, the picture has begun to change – thanks to the stabilization of the macroeconomic situation and lower interest rates, and people have turned their attention to alternative financial instruments. Also, the entire collective investment industry – brokers and managers – has taken an enormous step in the field of digitalization, and becoming an investor has become dull. The largest banks also made a massive contribution to attracting citizens to the stock market. The process of “cannibalizing” deposits has begun, allowing banks to retain customers, increase their commission fixed income, and reduce contributions to the deposit insurance fund and reserves. The state also made its contribution by introducing tax benefits and canceling personal fixed income tax for coupons on corporate bonds. As a result, 2018 was a record year both in the number of citizens in the financial market and the number of funds in their accounts.

Opinions of market participants about the prospects for 2019

Some believe that the factors that have played a decisive role in the past few years will play against the bond market next year – deposit interest rates have started to rise again, and the return on investment for the year, especially for bonds, will not be awe-inspiring. We will have to make more efforts to maintain the trend. But some optimists believe that in 2019 the mass exit of individuals to the bond market will continue, despite the dubious prospects of the bond market itself, this will happen thanks to large banks and their technologies.

What attracts citizens to the financial market

Interest rates at large banks fell below 7% and could no longer provide the desired double-digit returns, which private investors had become accustomed to in previous years. In search of an alternative, they began to opt for the stock market and collective investment products: mutual funds, trust strategies, which, in turn, showed desirable rates of return.

Banks also have economic benefits of transferring part of their deposits to investments – there are no deductions for these funds to the deposit insurance fund and the reserve fund. Interest in securities provides banks with a reduction in the cost of servicing their deposit portfolio. Also, many bond market privacy policy participants explain the interest of citizens in diversifying their investments by increasing the level of financial literacy.

Posted: 2.07.2020 | Alex Feldman
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