Apart from collecting money from tax payers like you and me, governments also borrow money in the international capital markets. They do this by auctioning their debt in the form of bonds, interest-bearing instruments that can then be bought and sold in the market. When opening a spread betting or CFD trading account, you will be given access to a range of government bond markets.
Spread betting and CFD companies quote prices on a series of bonds issued by major governments, including the US, the UK, and Germany. These are the most actively traded bond markets. UK bonds are typically referred to as ‘gilts’, while US bonds are called ‘Treasuries’ or ‘Treasury notes’.
The popular, or ‘benchmark’, bond issues are the 10 year bonds. This means the bond is issued with a 10 year lifetime. The government is promising to pay back the holder of the bond the full amount borrowed in 10 years’ time. Meanwhile, the government will pay the rate of interest attached to the bond when it is first issued throughout the life of the bond.
Most financial spread betting and CFD trading companies will quote prices on both US and UK 10 year government bonds. They will also typically quote prices on German government bonds. These are divided up into short term (two year) bonds called Euro Schatz, medium term (five year) bonds called Euro Bobl, and long term (9 years +) bonds called Euro Bunds.
Governments issue bonds with different maturities because their financing requirements are different: they need to access short term as well as long term money in order to make sure they balance their books.
When spread betting these markets, it is important to understand that you do not own the underlying bond. No government is borrowing from you, and no government will pay you back in 10 years’ time. Indirectly, via your financial spread betting company, you are trading futures markets based on the prices of government bonds. Traders of bond futures (and customers of spread betting companies) look to make a profit from the change in price, not from the interest that governments pay on the bonds.
When trading government bond markets via spread betting or CFDs, you are focusing on the financial health of the government that is issuing that bond. Economic forecasts, statistical reports by the government (unemployment or inflation numbers for example), any indicator about how well the country’s economy is doing can affect the price of its bonds. Most importantly, traders try to predict where the country’s base interest rate is going to go. In many cases, the higher the interest rate, the more expensive the bond price is likely to be (investors will pay higher prices for higher income).
If it looks like a government is going to start raising interest rates, those bonds it has already issued with lower rates will get cheaper: investors will be less keen on them than on the newer, shinier bonds coming out with higher rates of interest. By contrast, if the government is cutting rates, and paying less money for what it borrows in the market, those higher paying bonds it issued five years ago will start to look more attractive, and their price will go up.
When trading bond markets using a financial spread betting account, it is important to pay attention to discussions about bond yields. A bond’s yield is a simple measure of how much of the current value of the bond is represented by the amount paid out in interest. The lower the bond price goes, the higher the yield becomes. If a bond pays out 5% a year on £100, its yield will be 5%. If its price then falls to £90, that 5% rate now accounts for a yield of 5.556%. Thus, when market commentators talk about yields going up, this means prices are going down.
Using a spread betting or contracts for difference account to trade bond markets means you will also benefit from trading on margin. This can be important if you want to make a profit, as the prices of bonds will only change incrementally over days or weeks. Spread betting on margin means you only need to deposit a proportion of your spread bet or CFD trade, while your spread betting account provider lends you the rest. Once you close your spread bet, you pocket the full value of any profit or loss made from the trade. This can, of course, mean you lose more money than you initially deposited, so it is important that you protect yourself against losses with a stop loss (an automatic sell order if the bond price falls to a certain point you specify).
Trading bond markets with financial spread betting also means you don’t have to worry about currency risk. If you were buying a foreign debt security, like a US government bond, as a UK investor you would also be taking on the risk of any fall in the pound against the dollar. A spread betting company will be able to hedge out the foreign currency risk for you, letting you concentrate on just the change in the bond price.