History
Bonds have been around for centuries, dating all the way back to the 17th century in the Netherlands. They were used by Dutch merchants to finance their businesses, and by the Dutch government to finance wars and have since become an essential component of the global financial system.
Bonds are now issued by governments and corporations all over the world to fund operations, infrastructure projects, and other ventures.
Definition
A bond is a type of financial instrument that represents an investor’s loan to a borrower. Bonds are typically issued by governments or corporations in order to raise capital. When a bond is purchased, the investor is effectively lending money to the bond issuer.
In exchange, the bond issuer promises to repay the principal (the initial amount invested) along with interest payments over the bond’s life.
How it works
Bond issuance occurs when the bond issuer (typically a government or corporation) decides to raise capital by issuing bonds. They decide how much money they want to raise, when the bonds will be paid off, and what interest rate they are willing to pay.
1. Bond sale: The issuer sells bonds to investors, who can buy them from the issuer directly or through a broker. The bond’s price is determined by several factors, including the issuer’s creditworthiness, the maturity date, and the interest rate.
2. Bond ownership: When a bond is purchased, the investor becomes the bondholder. The bondholder is entitled to interest payments for the duration of the bond, as well as principal repayment when the bond matures.
3. Interest payments: The bond issuer pays the bondholder interest on a regular basis. These payments are usually made once a year or twice a year and are based on the interest rate specified when the bond was issued.
4. Bond maturity: When a bond reaches maturity, the issuer is required to repay the principal to the bondholder. The bondholder has the option of reinvesting the principal in another bond or cashing out their investment.
Bond types
| Type of Bond | Pricing | Peer Group | Pros | Cons | Popular Examples |
|---|---|---|---|---|---|
| Treasury Bonds | Typically sold at auction and priced based on yield | Considered the safest investment | Backed by the full faith and credit of the U.S. government | Lower yields than other types of bonds | 10-Year U.S. Treasury Bond |
| Corporate Bonds | Priced based on yield spread over U.S. Treasuries | Vary by industry and credit rating | Typically offer higher yields than Treasuries | Credit risk and default risk | Apple, Inc. 10-Year Bond |
| Municipal Bonds | Priced based on yield spread over U.S. Treasuries | Issued by state and local governments | Tax-exempt at the federal level and often at the state level | Can be impacted by changes in the financial stability of the issuing government entity | New York City Municipal Bond |
| High-Yield Bonds | Priced based on yield spread over U.S. Treasuries | Also known as “junk bonds” | Offer higher yields due to increased credit risk | Higher default risk than investment-grade bonds | Ford Motor Company 10-Year Bond |
Usage
Bonds are used to raise capital by both individuals and organizations. Individuals can purchase bonds directly from the government or corporations in order to earn a fixed income over a set period of time.
Organizations, on the other hand, can issue bonds to raise capital for projects or to expand their operations.
•Goverments: Bonds are used by governments to fund activities such as infrastructure projects, social welfare programs, and defense spending.
For example, the US Treasury issues bonds to fund government spending, which are then purchased by investors.
•Individuals: Individuals may invest in bonds to generate a consistent income stream or to diversify their investment portfolio.
Bonds are considered less risky than stocks because the fixed interest rate provides a predictable return on investment and the bondholder’s principal investment is returned at the end of the bond’s term.
Bonds vs Fonds vs Time deposits vs Stocks
| Category | Bonds | Fonds | Time Deposits | Stocks |
|---|---|---|---|---|
| Definition | Debt security issued by a company/government | Investment fund managed by professionals | Savings account with fixed interest rate and term | Equity ownership in a company |
| Risk | Low | Low to High | Low | High |
| Return | Fixed interest payments and principal repayment at maturity | Varies depending on fund performance | Fixed interest rate for a set term | Potential for capital appreciation and dividends |
| Liquidity | Low to Medium | Medium | Low | High |
| Investment | Generally considered safe | Diversified portfolio of assets | Considered safe | High risk but potentially high reward |
| Time horizon | Short to Long-term | Long-term | Short-term to Medium-term | Long-term |
| Accessibility | Accessible through brokers or banks | Accessible through brokers or banks | Accessible through banks | Accessible through brokers or apps |
Bond Pricing
1. Interest rates: Bond prices fall when interest rates rise, and bond prices rise when interest rates fall. This is due to the fact that as interest rates rise, newer bonds will offer higher yields than older bonds, making older bonds less valuable.
2. Credit rating: The issuer’s credit rating influences bond pricing. A bond issued by a higher-rated issuer is considered less risky and may have a lower interest rate than a bond issued by a lower-rated issuer.
3. Time to maturity: Because there is more risk associated with holding a bond for a longer period of time, longer-term bonds generally offer higher yields than shorter-term bonds.
4. Inflation: As inflation rises, the value of a bond’s future cash flows falls, causing bond prices to fall.
Here are some examples of bond pricing factors in action:
1. If the Federal Reserve raises interest rates, the price of existing bonds typically falls as investors shift their money to higher-yielding bonds.
2. A bond issued by a large, well-known corporation with a high credit rating may have a lower interest rate than a bond issued by a smaller, less well-known corporation with a lower credit rating.
3. Because the investor is taking on more risk by tying up their money for a longer period of time, a 10-year bond will typically have a higher interest rate than a 1-year bond.
If inflation rises, a fixed-interest-rate bond may lose value because the future cash flows promised by the bond will be worth less in real terms.
Pros and Cons
Pros
• Fixed interest rate: Bonds have a fixed interest rate, which provides investors with a predictable income stream.
• Diversification: Bonds allow you to diversify your portfolio by investing in various types of bonds issued by various issuers.
•Lower volatility: Bonds are less volatile than stocks, making them an excellent choice for conservative investors or those nearing retirement.
• Credit rating: Bonds have credit ratings that can help investors determine the issuer’s creditworthiness.
Cons
• Lower return: Bonds typically provide lower returns than other types of investments such as stocks or real estate.
• Sensitivity: Bonds are sensitive to changes in interest rates, and their value may fall if interest rates rise.
• Inflation risk: Bond fixed interest rates may not keep pace with inflation, eroding the purchasing power of the investor’s returns.
• Default risk: There is always the possibility that the bond’s issuer will default on the interest payments or the principal amount.
Bond yield indicators
•Current Yield: This indicator calculates the annual return an investor will receive if they hold a bond for a year. It is calculated by dividing the annual interest payment of the bond by its current market value.
•Yield to Maturity (YTM): This metric represents the total return an investor will receive if he or she holds a bond until maturity. It considers the bond’s current price, face value, coupon rate, and time remaining until maturity.
•Real Yield: This indicator measures an investor’s return after adjusting for inflation. It is calculated by subtracting the nominal bond yield from the inflation rate.
•Yield to Call (YTC): This metric calculates the return an investor will receive if the issuer decides to call the bond before it matures. It considers the bond’s current price, the call price, the coupon rate, and the time until the call date.
•Yield Curve: This indicator depicts the relationship between bond yields and maturity dates. Longer-term bonds have higher yields than shorter-term bonds, according to a normal yield curve.
Bonds abroad and in own country
| Category | Bonds Abroad | Bonds in Own Country |
|---|---|---|
| Pricing | Affected by exchange rates, political and economic risks, taxes and fees | Affected by interest rates, Inflation, Credit rating, and taxes |
| Peer Group | Foreign government bonds, Corporate bonds, High yield bonds | Government bonds, Municipal bonds, corporate bonds |
| Pros | Diversification of portfolio, Access to higher yields, potential currency gains | Lower risk, Relatively stable, Easier to understand |
| Cons | Higher risk due to political and economic factors, currency fluctuations, Complexer regulations | Lower yields, Limited diversification, affected by domestic economic conditions |
| Popular Examples | Japanese government bonds, German bonds, US Treasuries | US Treasuries, Municipal bonds, Corporate bonds |
Buy and Sell Bonds
Buying
1. Choose the type of bond you want to buy: Corporate, government, municipal, or other.
2. Examine the available bonds: Discover the issuer, coupon rate, maturity date, and credit rating of the bond.
3. Open a brokerage or bank account for investment purposes: The account must be funded with the amount you intend to use to purchase bonds.
4. Make a purchase order for the bond: Indicate the name of the bond, the quantity, and the price you are willing to pay.
5. Allow time for the order to be filled: Depending on market conditions, the order may be executed immediately or after some time.
6. Pay for the bond: When the order is filled, the purchase price is deducted from your account and the bond is credited to your account.
Selling
1. Determine the bond’s value by doing the following: Check the bond’s current market value to see how much it’s worth.
2. Contact your broker: Inform them that you want to sell the bond and provide specifics about the bond.
3. Put in a sell order: Indicate the name of the bond, the quantity, and the lowest price you are willing to accept.
4. Allow time for the order to be filled: Depending on market conditions, the order may be executed immediately or after some time.
5. Receive your earnings: The sale proceeds will be credited to your account once the order is filled.
Bonds investing in the future
It is difficult to predict whether bond investment popularity will rise in the future because it is affected by a variety of factors such as economic conditions, interest rates, and investor preferences.
However, bonds have historically been a popular investment option for many investors due to their perceived safety and reliability when compared to other investment options such as stocks. Bonds can also be used to diversify an investment portfolio and provide a consistent stream of income through coupon payments.
However, there are some drawbacks to investing in bonds, such as the risk of inflation eroding the value of fixed income payments and the risk of the bond issuer defaulting.
FAQ
How do bail bonds work?
Bail bonds work by allowing an arrested individual to be released from jail while awaiting trial by paying a certain amount of money to the court.
This sum of money is known as bail, and it serves as a guarantee that the person will appear in court for their trial.
If the arrested person cannot afford to pay the bail amount, they can seek help from a bail bond agent. The bail bond agent will charge a fee, usually 10% of the total bail amount, and then provide the court with a surety bond. This bond guarantees that the individual will appear in court for their trial, and if they do not, the bail bond agent is obligated to pay the full bail amount.
The arrested person will be released from jail once the bail bond agent has posted the surety bond. They will, however, be required to adhere to certain conditions, such as attending all court hearings and remaining within a specific geographic area. If they do not follow these conditions, the court may revoke their bail and send them back to jail.
If the person appears in court as scheduled, the bail money or surety bond will be returned to the bail bond agent, less any fees or expenses. The bail bond agent will retain the fee for their services.
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