Why buy bonds in a no-arbitrage market?


Rates are a complex field.

I will assume that context wise you are talking about rates for a individual saver quantities.

The two rates you are asking about are personal bank saving account and exchange traded bonds.

The points you want to compare between them are.

  • Fixed vs Floating Interest Rate
  • Term structure/Maturity
  • Counter-party risk

Fixed vs Floating Rate

In general, a bond is what we called a fixed rate instrument. This means that for the life of the product, it will yield a fixed percentage of its face value at a regular period. Baring any extreme circumstances (such as bankruptcy), no external factors will change the payment schedule on a bond.

Conversely, by placing your money into a bank, you will accrue interest rate at some value related to some published interest rate. For example, if tomorrow, the Treasury decided to try to stimulate the economy, they could slash the interest rate, this would directly affect the rate at which your savings account would accrue interest.

Maturity

In general, a bond has a maturity date, where the capital is finally released from the bond. Until such date, you cannot access the money directly (you can however sell the bond, but it would likely be at a discounted value). Therefore, in general, you cannot get access to the money whenever you want it.

As for a saving account, normally one can access the funds instantly, if not within a few days.

Counter Party Risk

This seems to the reason people seem to be focusing on.

For each bond, the issuer of the bond is obligated to pay you the holder of the bond fixed payments at an interval, plus the capital at the maturity. However, obligation does not mean guarantee. If the issuer, is unable to make the payments, they may go into bankruptcy to avoid paying you.

There are companies setup to advise people on the likelihood of each bond issuer on their ability to honour their debts. For example Standard and Poor issues a rating which goes all the way up to AAA for bonds. Recently, many sovereign countries have lost their AAA rating from S&P. Meaning that S&P feel that the possibility of these countries going bankrupt is non-zero.

Conversely, banks may also be unable to give you your money when requested. In the US, the reserve requirements means that at any one time it only holds 10% of the money it owes to its customers. This can mean that if every customer turns up to the bank to demand their money, that bank would be unable to pay.

This situation is called a Bank Run. During such a situation, the bank would likely collapse and default. In many modern countries, the government put into place guarantees on the first xxx amount in saving accounts, but otherwise, your savings could be lost.

Conclusion

There are many complex reasons to choose one instrument over another (including some I have avoided), even if at the outset, they could appear to have the same rates.


For safety. If something catastrophic happens to your bank and your money is in there you will lose any not covered by FDIC. So if you have a very large amount of money you will store it in bonds as its much less likely that the US treasury will go bankrupt than your bank.

I also literally just posted this in another thread:

Certain rules and regulations penalize companies or institutions for holding cash, so they are shifting to bonds and bills. Fidelity, for example, is completely converting its $100 billion dollar cash fund to short term bills. Its estimated that over $2 trillion that is now in cash may be converted to bills, and that will obviously put upward preasure on the price of them. The treasury is trying to issue more short term debt to balance out the demand. read more here: http://www.wsj.com/articles/money-funds-clamor-for-short-term-treasurys-1445300813


If by "putting money in the bank" you mean regular savings or checking, then the bond locks a rate for a period of time, whereas your savings/checking rate can vary over that period. That variation might go for you or against you. Depending on your situation, you might prefer to take a determined rate to the variations. In addition, some bond types provide tax benefits (e.g. treasuries and municipal bonds) that change the effective return - You cannot just compare the interest rates.

Finally, the bonds have "resale" value on the secondary market like stock - Depending on your outlook and strategy, you might by the bond for its value as a security rather than for the interest specifically just like you'd could buy a dividend-paying stock for its value as a security rather than for the dividend. In other words, you might think that bond values are going up, so you buy bonds with the intent of making a capital gain rather than counting on the interest returned. (The bond market does depend on the interest rate, so these are not independent factors.)

I see the other answer that mentions the potential for your bank busting and you losing money beyond the FDIC insurance limit. The question doesn't specify U.S. Government bonds though, so I don't think that answer is generally good. It would be good in the case that you had a lot of money (especially an institution or foreign government) and you were specifically interested in U.S. Treasury bonds. Not so much if you invest in corporate bonds where you have no government insurance / assurance of any sort. Municipal bounds are also not backed by the U.S. (federal) government, but they may have some backing at the state level, depending on the state.