How to Compare Fixed Rate Bonds

Executive Summary

With a broad universe of government, bank and corporate bonds available to Australian investors, comparing individual bonds on a genuinely like-for-like basis requires more than simply lining up headline coupon rates. This article sets out a general framework — covering yield to maturity, credit quality, duration, liquidity and structural features — that investors may find useful when assessing and comparing fixed rate bonds.

Start With Yield to Maturity, Not Coupon

As discussed in our companion article on coupon versus yield to maturity, the coupon rate alone does not tell an investor what return they can actually expect from a bond purchased at a given price. When comparing two or more bonds, yield to maturity provides a more standardised basis for comparison, because it incorporates the purchase price, coupon payments and return of face value into a single annualised figure. For a purely illustrative example, a hypothetical bond with a 3% coupon trading at a discount might offer a similar or even higher yield to maturity than a hypothetical bond with a 5% coupon trading at a substantial premium — underscoring why coupon rate in isolation is an unreliable basis for comparison.

Match Credit Quality Before Comparing Yield

It is generally only meaningful to compare yields across bonds of broadly similar credit quality and maturity; comparing the yield of an investment grade corporate bond against a sub-investment-grade bond without accounting for the material difference in credit risk between the two is generally not a useful exercise. A more constructive approach is to compare yields within a similar credit tier — for example, comparing several BBB-rated corporate bonds of similar maturity against one another — to identify potential relative value, while separately assessing whether stepping into a lower credit tier for additional yield is appropriate given one's own risk tolerance.

• Compare bonds within similar credit rating bands before drawing conclusions about relative yield attractiveness.
• Use government bond yields of comparable maturity as a general reference point for assessing credit spreads.
• Consider both the issuer's overall credit profile and the specific bond's seniority within that issuer's capital structure.
• Be cautious of bonds offering meaningfully higher yields than peers of similar apparent credit quality — this can sometimes signal additional risk not immediately obvious from a rating alone.

Align Duration With Your Objectives

Duration allows investors to compare the relative interest rate sensitivity of bonds with different maturities and coupon structures on a standardised basis, as discussed in our companion article on bond duration. When comparing bonds, it can be useful to consider not just the yield on offer, but also how much interest rate risk an investor is taking on to achieve that yield. A hypothetical shorter-duration bond offering a slightly lower yield may be more appropriate for an investor prioritising capital stability, while a hypothetical longer-duration bond offering a higher yield may suit an investor with a longer time horizon and greater tolerance for interim price fluctuation.

A meaningful bond comparison starts by holding credit quality and maturity roughly constant, then asking what the market is actually paying for the remaining differences.

Don't Overlook Liquidity and Structural Terms

Liquidity — how easily a bond can be bought or sold on the secondary market without materially affecting its price — can vary considerably, particularly between large, frequently traded government or bank bond issues and smaller or less frequently traded corporate bonds. Investors who may need flexibility to sell before maturity should factor general liquidity conditions into their comparison, rather than focusing solely on yield. Structural features are equally important: a callable bond, for example, may be redeemed by the issuer prior to its stated maturity under certain conditions, which can affect the realistic yield an investor should expect, generally captured by a separate 'yield to call' calculation alongside yield to maturity.

Key Considerations for Investors

• Always compare bonds on yield to maturity, adjusted for purchase price, rather than headline coupon rate alone.
• Hold credit quality and maturity broadly constant when assessing relative yield attractiveness.
• Use duration to compare interest rate sensitivity across bonds with different structures.
• Factor in liquidity conditions, especially if you may need to sell before maturity.
• Review any call provisions or other structural features that could affect realised returns.

Conclusion

Comparing fixed rate bonds effectively requires looking beyond the headline coupon to consider yield to maturity, credit quality, duration, liquidity and structural terms together. Applying a consistent framework across these factors can help investors make more informed, like-for-like comparisons across the diverse universe of available bonds. This article is general information only and does not constitute personal financial advice.

Related topics

Information contained within these insights is provided for general information purposes only and does not constitute personal financial advice, an offer or recommendation to acquire or dispose of any financial product. Investors should consider their individual circumstances and obtain appropriate professional advice before making investment decisions.