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Bonds – Getting Your Feet Wet

October 17, 2012 in Bond

 

 

 

 

 

 

 

 

 

Investment in Bonds:

Now we have picked up the basics of bonds and understand the risks involved, it’s time to get your feet wet and invest in bonds either directly or through a bond fund.

Here are a few points you should keep in mind before you embark on this new investment journey in the bond market.

Bonds and Research, research, research…

Go through the bond terms with a fine tooth comb and understand all the implications. Examine the kind of bond it is, whether it has any call provisions, rates of interest payment, current yield, YTM (Yield to Maturity) and interest accrued on the bond after the last interest payment date. Like any investment, bonds also need a thorough research before we go for buying those.

Bond research

 

 

 

 

 

 

 

 

Check out the bond issuer, their interest coverage ratios, debt-to-equity ratio and whether there is any past history of default and also the future possibilities for the same.

Bond ratings

Assess the likelihood of prompt interest payment and safety of principal by checking out the ratings, if any issued by agencies such as Moody’s and S&P. Understand that these are only rough and ready guides, and may not be entirely current.

Bond ratings

 

 

 

 

 

 

 

Guard Yourself Against Inflation

One great way protect yourself and your capital from the vagaries of inflation is to buy bonds which are protected from inflation risks –TIPS, or, Treasury Inflation Protected Bonds, ensure that the investment is protected against inflation. How do these work?

These are a kind of Treasury bonds of face value $ 1000 to which is added every year an amount representing the percentage rise in the Consumer Price Index (CPI). This way the inflation risk is removed, and because these are bonds issued by the Treasury, so is default risk.

Temptation of Investing in Junk Bonds

If you’re drawn to high yielding bonds, a.k.a. “junk bonds”, these are better bought through the vehicle of a junk bond fund that has a low expense ratio. The expenses you pay are justified by the diversification achieved, something you may not be able to do on your own by buying up individual bonds. The diversification affords protection against the occasional bad apple default.

The Tax Advantage

If you’re paying a lot of taxes, it makes sense to opt for tax-free bonds. The interest earned on these bonds is exempted from tax and to that extent, your yield is improved.

Tax advantage on bonds

 

 

 

 

 

 

 

You should calculate, with reference to your tax rate, the net earning on a tax-free bond and that on a normal bond. Compare the two returns and decide accordingly.

What’s Age Got To Do With It?

A lot! Did you know there was a very convenient rule of thumb to calculate how much of your investable funds should go into bonds?

When to invest in bonds - Retirement Planning

 

 

 

 

 

 

Take your age – that is the percentage of your assets that should go into bonds and the balance into riskier assets such as stocks. So, the higher your age, the more your investments in the comparatively safer bonds.

Bonds and Investment Timing

Ideally, move into bonds when the interest cycle is at its peak. Remember your basics? When interest rates are high, bond prices will be low, and vice versa.

If you buy bonds when interest rates are high, you would be likely buying them at very low prices. If you have timed it correctly, or are even reasonably close, interest rates should be falling off and bond prices will start ticking up. So, apart from your interest earnings, you could also earn some nice capital gains!

Laddering

This is a technique for investing in bonds which minimizes the interest rate risk borne by the investor.

Bond and laddering

 

 

 

 

 

 

 

 

 

This is achieved by investing in a bond portfolio a part of which matures every successive year. Thus, an investor could decide to invest 20% of its portfolio in a bond that matures next year, another 20% in the second year, and so on until he is fully invested by the fifth year. As each of these mature, the proceeds of redemption are reinvested in bonds of five-year maturities. In this manner, the investor is always possessing five sets of bonds that are each maturing every year, over the next five years.

By investing in comparatively short-term bonds, which carry the lower interest rate risk, the investor is cushioned against large interest rate impacts. Also, by investing the maturity proceeds every year, the investor stays in step with the interest rate cycle.

Investing in Bonds – Summary

No investment is without risk and that hold true with the bonds also. Bonds may carry less risk than other financial instruments but they do not come risk free. The other factor is that the returns on the bonds may also be less than some other high risk-high gain investment options. One of the thumb rules of investing is to diversify the portfolio. A diversified portfolio would have some high risk and high gainer options and other options which are safer but give less returns. Considering this first thumb rule of investment, check out all the factors mentioned above for a thorough research before investing in the bonds.

Further resources

1) What are Bonds?
2) Types of Bonds
3) Bond Terminology
4) Bond Yield and Yield to Maturity
5) Bond and Inflation
6) Bond Risks

Bond Risks

October 13, 2012 in Bond

Bond risks

If you thought bonds were fail-safe and risk-free, please think again.

The fact is that bonds too, like most other investments, are subject to risks; however, the kind of risk, or its degree, may vary.

Bond Default Risk

Bond default risk is the risk one runs that the issuer of the bond may not be able to pay interest during the tenure of the bond, or repay the principal on its maturity.

This ability of the bond issuer to meet his commitments is based on his credit-worthiness, which in turn can be gauged by the issuer’s credit rating assigned by rating agencies such as S&P and Moody’s, as shown below. Borrowers with high ratings are more credit-worthy, and hence less likely to default on their bond commitments.

Therefore, one may decide to invest in bonds issued only by high-quality borrowers. But this added security has a price – one may have to settle for lower coupon rates. Conversely, a lower-rated borrower may have pay higher interest to attract investors to their bonds.

This is shown very well in the illustration below relating to yields on sovereign bonds.

Government Bond Yields

Chart Courtesy FT,com

Clearly, in the above chart, Spanish and Italian government bonds are showing the highest yields because of their imminent default risk. Why?

Default risk > Low Bond Prices > Higher Yields

Interest Rate Risk

This is the risk inherent on a bond due to a change in the market interest rates. Suppose that interest rates move up after the issue of a bond. In that case, a person considering an investment in those bonds will seek to pay a lower price so that his effective interest earning will be in line with current market interest rates. This will cause the prices of those bonds to fall.

Therefore, when interest rates increase, prices of bonds fall. Conversely, when interest rates fall, bond prices appreciate, as shown in the following illustration:

Thus changing interest rates have an important impact on the value of a bond investment, and can be a source of great risk during times of hardening interest rates. Interest rate risk is more pronounced on bonds with longer tenures.

Purchasing power risk

The decline in the purchasing power of a currency, which is directly related to the inflation level in the economy, also affects bonds. As the interest and redemption amount on a bond are fixed, a decline in purchasing power means that the investor will effectively get a lower return on his investment.

Therefore, bonds fall in value during periods of rising inflation. During periods of low inflation, bond prices stay firm so long as the interest is higher than the rate of inflation.

Liquidity risk

This is the risk that an investor faces when he attempts to transact in a bond that is not actively traded. In such a case, the investor may have to pay a higher price to obtain the bond, or settle for a lower price when he’s out to sell.

Event risk

Sometimes the borrower issuing the bonds becomes the subject of a corporate transaction such as a merger or acquisition. One result of the transaction may be that the credit worthiness of the bond issuer may be prejudiced, resulting in a fall in prices of that bond, and a loss to the investor.

Call risk

This is the risk assumed by an investor that the bond issuer would redeem the bonds prior to their maturity, provided the bonds carry this option.

Normally issuers prefer up to call up the bonds in a situation of falling interest rates, and when the prevailing rate falls below the coupon rate on the bonds. Needless to say, the action benefits the borrower and deprives the investor of profits.

Further resources

1) What are Bonds?
2) Types of Bonds
3) Bond Terminology
4) Bond Yield and Yield to Maturity
5) Bond and Inflation
6) Investment in Bonds

Bond Yield and Yield to Maturity

October 4, 2012 in Bond

Bond yield is nothing but the return on bond investment. So suppose we buy the bond at the time of issue at a issue price or face value of 100 USD and the annual interest offered on the bond is 10% then our annual return or annual coupon value would be USD 10. The current yield on that bond would be the coupon value divided by the face value i.e. 10/100 = 10%. Hence on a new bond the current yield is equal to the interest rate returns on that bond.

Bond Yield

The Bond Yield formula is as follows:

Yield on Bonds = (Coupon Value) ÷ (Face Value).
Bond - Yield to MaturityNow what happens if the market price of that bond changes. Let’s say that the inflation has gone up and hence the benchmark interest rates also. As we have seen above the market price of your bond would go down. Let’s say that the market price has gone down to 90 from the original 100. The point to be noted that even if the market price has gone down but the coupon value would remain same.

So now the current yield on that same bond = 10/90 = 11.11%. If I buy the bond at USD 90, my returns are better than the original yield of 10%. But is it enough to make my decision about the bond purchase?

No, it is not. What I would like to see is what would be total returns against the investment on that bond, assuming that I buy today and keep that bond till the maturity period.

Bond – “Yield to Maturity”:

Yield to Maturity (YTM) is nothing but the total returns on a bond if we keep the bonds till their maturity period.

Suppose the bond has 4 years remaining till it’s maturity date then the simplest formula for yield to maturity would be as follows:
Yield to maturity = Coupon value for 1st year + Coupon value for 2nd year + Coupon value for 3rd year + Coupon value for 4th year + The face value of the bond when we redeem it.

We will not go into the mathematical formula because the above example is the very simple yield to maturity. There may be different kinds of bonds i.e. Zero Coupon Bonds and all and the calculation would differ. Also in the above example we have take full 4 years but it could be 3 and half years or 7 years 2 months, just for example. What we wanted to cover is the concept of yield to maturity and hope that it is clear now.

Further resources:

1) What are Bonds?
2) Types of Bonds
3) Bond Terminology
4) Bond and Inflation
5) Bond Risks
6) Investment in Bonds

Bond – Interest Rate and Inflation

October 4, 2012 in Bond

Bonds are issued at a par value (face value) by the issuer and the investor gets the returns on his investment by the coupon value depending on the offered interest rate. The interest rate offered on bond would be more than the key interest rate or benchmark rate and that would be the only reason that a bond would be a more attractive investment than simply keeping your money in a bank. Please note that till now we are talking about the primary market i.e. when new bonds are issued.

Bond and Inflation

Bond and Inflation Bond and Interest Rates

Now what happens if the inflation rises. Inflation rises because of demand and supply gaps. The demand is more than supply and the prices go up. Or the money supply in the market increases and people have more money to spend and the prices start going up.

Now when the inflation goes up, the central banks increase the interest rates to control the money supply. With increased interest rates borrowing the money becomes costlier and hence the money supply gets controlled. But when the benchmark interest rates goes up then the difference in what interest rate you are getting on your investment on bonds and the benchmark interest rate goes down. If there is a drastic rise in the inflation rate and hence interest then even the difference may become negative. The end result is that your purchased bond become a less attractive investment. Now who would like to be stuck with a less attractive investment? The result would be that the market price of the bond would go down. Suppose the face value of the bond was USD 1000 but now when the returns on that bond have become less attractive, you can’t sell that on the market price. The opposite of this would also be true i.e. if the benchmark interest goes down because of a drop in inflation then your bonds will become a more attractive investment as what you are getting as returns is now much better than the market interest rates. At such times the market price of the bond will go up.

Bonds in Secondary Market

Now suppose I wish to buy a bond at the from the secondary market at the current market price, how I would analyze if my investment is worth or not? Simply speaking I will have to compare my investment with the total returns on the bond assuming that I hold the bond till the maturity period. Here comes another term into the picture called “Yield to Maturity”. Please check what are bond yield and yield to maturity (YTM) at Bond Yield and Yield to Maturity.

Further resources:

1) What are Bonds?
2) Types of Bonds
3) Bond Terminology
4) Bond Yields
5) Bond Risks
6) Investment in Bonds

Types of Bonds

October 2, 2012 in Bond

Before we talk about different types of bonds, let’s take a look as to what are the possible variables associated with a bond. Logically the variables which can define the types can be as follows:

  1. Who Issues the bond
  2. Tenor or maturity period
  3.  Interest Rate
  4. Interests rate and principal amount payment options

Type of Bonds

 

1) Type of Bonds Depending on Who Issues the Bond.

Bonds can be issued either by Government or companies or even city governments or municipalities. Hence according to the issuing entity or borrower the types of the Bonds are as follows:

a) Government Bonds

In US these are also called Treasuries. Government Bonds are the bonds issued by the Governments of the countries.

b) Corporate Bonds

These are the bonds issued by corporations/companies to fulfill the needs of cash for assets and/or operations.

c) Municipal Bonds

Municipal Bonds are the bonds issued by the local municipalities of cities for their needs of cash to run the city and it’s infrastructure.

2) Type of Bonds (Debts) Depending on The Tenor or Maturity Period

Bonds generally have a fixed tenor or maturity period. Different countries may have different nomenclature according to the maturity period but if we talk in terms of US then the basic types of treasuries are as follows:

  • Bills: Less than one year maturity period. Strictly speaking these are not bonds because of such a short span of time and hence can simply be called Debt Securities or Treasury Bills.
  • Notes: 1 to 10 years. These are also called as Treasury Notes.
  • Bonds: 10 or more years.

Now the Bond types according to the maturity time as mentioned above are the standard types of bonds with fixed tenor or maturity period. As mentioned above that some or other type of customization is always possible for any financial instrument to make it more convenient or profitable or efficient for either the borrower or the lender. Considering this there are some other versions as follows:

a) Callable Bonds (Bonds with Call Option):

Bonds with call options or recall options are known as Callable Bonds. Now let’s see what is “Call Option” and why it is required. As we have seen that all bonds normally have a fixed interest rates (we will see the exception later) and a fixed maturity date. Now it may happen that the market interest rates falls drastically because of drop in inflation or rise in deflation. Let’s say that the market interest rates go far lower than the interest rates offered on the bond. Where will that leave the issuer? The issuer of the bond will be paying lot more interest than what was actually planned in terms of the difference of bond interest rate and market interest rates. If the Issuer has the option to recall all the bonds or the part quantity of the same then that higher cost can be saved. Similarly if the interest rates of the currency in concern goes drastically high then it is against the interests of the investors to keep their money stuck with those bonds which are paying much less interest.

The above could be two of the reasons and the third reason is simply the convenience of the flexibility to bring down the maturity period. The Callable bonds give the issuer the right to bring down the maturity period. They can recall the bonds at any date before the maturity date. The Call Price or the redemption price has a premium over the face value of the bond i.e. the call price would be more than the par value or the face value of the bond.

Now there are again two types of Callable bonds or call options:

a1) American Call Option:

Under American call option the issuer can exercise the call option anytime before an specified date.

a2) European Call Option:

Under European call option the issuer can exercise the call option only on specified date(s).

There can again be 2 more types of Callable Bonds and these are as follows:

a3) Refundable Bonds

Let’s say that the benchmark interest rates go down drastically before the maturity period of the bonds. Now if the issuer issues new bonds with lesser coupon value (interest rate) then he will have to pay less  money as interest on the same borrowed money. So the issuer issues new bonds with lesser coupon value. The old bonds are called back using the call option and the money for that is paid from the new amounts received from the new bond issue. Rights to this provision are called refundable Bonds.

a4) Non Refundable Bond

Non-Refundable bond will not have the right to pay the money back from any new issue of bonds but the money will be paid to the investors from the normal or general accounts.

Difference in Callable Bonds and Refundable Bonds or Call Option and refundable Bonds:

As we saw above that refundable bonds and non refundable bonds are 2 categories of call options or callable bonds. A callable bond can be refundable bond or non-refundable bond depending on the right of the issuer to pay for the purchase of bond (redemption) for executing the call option.

b) Puttable Bonds (Bonds with Put Option)

Puttable Bonds are opposite to Callable bonds as far as rights to reduce the maturity period is concerned. Puttable Bonds give the investors a right to Put Option i.e. the investors can put the bonds back or redeem those earlier than the maturity date. This makes these bonds a more favorable options for the investors as if the market interest rates are going high then they have an option to redeem their bonds and invest their money with better options of options with higher returns. It may also be possible that an investor needs the cash back because of any reason and hence having this option is always good for an investor.

c) Convertible Bonds:

As we saw earlier that the normal bonds are a fixed income instrument which get matured on a specific date or even earlier with the call or put option and the investors get their invested amount back. Convertible bonds are a customized version and as the name suggests, these bonds are convertible. Convertible bonds do get converted from Bonds to Equity. Or the owner of the bonds become from lender or the money to equity holder in the corporation. The date of conversion and at what price the conversion will take place are pre-decided while the original bonds are issued. Please note that the price of one bond and the price of one stock or share will be different and hence the conversion price has also to be decided. market price of that stock or share may be anything at the time of conversion and hence if the market price is higher than the conversion price then it goes in the favor of the investor. The convertible bonds can be fully convertible i.e. all the bonds are converted into equity or they can be partly convertible i.e. a percentage of the bonds held by the investor are converted into equity and the remaining percentage remain in the form of original bonds with original conditions.

3) Type of Bonds Depending on Interest Rate Options

The original concept of Bonds have a fixed annual interest rates. Some customization in this brings the following types of bonds:

a) Fixed Interest rate Bonds:

No customization and these are the original bonds which give you a fixed annual interest rates

b) Floating Rate Bonds:

As the name suggests that these bond have floating interest rates. If the benchmark interest rate of that country or economic zone changes then the interest rate on the bonds are also changed. Generally there would be some mark up on the bonds interest rates as compared to the normal or bench mark rate to make the investment on the bonds attractive for the investors. Now that markup would may remain same but if the benchmark rate goes down then the interest paid on the bonds also go down and vice versa.

Generally there would be a maximum (cap) and minimum limit (floor) that the interest rate can go beyond that to keep the safety factor.

c) Zero Coupon:

As the name suggests the Zero Coupon Bonds have a Zero Coupon value. These are also known as Deep Discount Bonds. Now the question comes that if the coupon value is zero then why would anyone invest money in those bonds? What about the returns on the investment? Well, the Zero Coupon Bonds are offered at a discount on the face value of the bonds. SO basically when you get the bonds, you get those at much lesser price than their face or par value and when you redeem those at maturity then what you get is the face value. So the difference in the face value of the bond and the discount which you had got at the time of issue is the return on the investment or profit.

d) Treasury Strips:

Treasury Notes are specific to U.S. and is an interesting concept. It may seem complicated concept but we will try to explain it in simple way.

Any bond has two components as far as money is concerned:

1) The principal amount of the bond

2) The interest amount per year till the maturity period.

The above two components together is what we get during the life cycle of the bond and up to the maturity period. Now let’s strip the bond. Take out the interest part or in other words break these two component apart and what we have got? Well, we have got the principle amount with fixed value to be receive on the maturity and we have got the interest part for the duration till the maturity. Now let’s say I want to sell or trade these separately. Let’s take the first part i.e. the Fixed Price of Bonds first. I want to sell it to someone. Will anyone buy that if there is no interest and hence no returns on the investment? Well someone can buy it if I offer it as Zero Coupon bond or bond offered at a discounted price. So one thing is clear that I can trade only the fixed part separately as Zero Coupon Bond.

Now what about the interest part. This is also a fixed amount to be paid over the period of time till maturity. Now I sell these also as a separate security as Zero Coupon Bond. I know the total interest amount and I sell it to someone at a discounted price as Zero Coupon Bond.

Well, the above concept is termed as Treasury Stripes. Stripped bonds where two components are traded separately. Please note that both can have different maturity period as those are already broken apart.

Treasury stripes are not issued directly to the individual investors but can be purchased and held through either financial institutions or government security dealers or brokers.

4) Type of Bonds Depending on Interests rate and Principal Amount Payment Options

a) Amortizing Bonds:

When we take a home loan from the bank basically in a way we become the issuer of a bond and the bank is the investor. The bank earns an interest which is higher than the benchmark rate of interest and that is their earning or returns of the investment. Now when we take a loan, we just pay installments which cover both, the principle amount as well as the interest payable. With our last installment paid we have paid everything including the initial principle amount.

The above is nothing but the concept of Amortizing Bonds. The principle amount along with the interest gets paid in equal 6-monthly installments and after the last amount paid at the maturity date there is no more fixed principle amount to be paid.

b) Sinking Fund Provision Bonds:

First of all let’s see what is “Sinking Fund Provision” and then “What are  Sinking Fund Provision Bonds”.

Let’s say you are a corporation of Government you the debt. Every portion of the debt will have some period of time by the end of that you will have to repay it. Now let’s say you have a debt which you have to pay after 10 years. Now for 10 years you will continuously having that liability. Wouldn’t it be better if you can reduce this liability periodically instead of waiting for those 10 years?

If the issuer of the bonds sets up a fund to periodically reduce the debt by buying back the debt (bonds) periodically then such a fund is called “Sinking Fund”. And this concept is known as  Sinking Fund Provision.

As we have seen that bonds are nothing but debt or money on loan. The issuer sells bonds to borrow money and he has that debt to be paid as liability till the maturity of the bonds. Now if the issuers keep on reducing that liability periodically instead of waiting till the maturity then the liability will keep on reducing. To summarize, you set up a fund which keeps on reducing your debt in parts over the years instead of waiting for all those years.

Difference in Bonds with Sinking Fund provision and Call Option:

At first glance it would look like the bonds with sinking fund provision are same as callable bonds i.e. bonds with Call Option but there are differences:

1) The issuer can purchase the whole quantity of bonds issues if he has the call option. On the other side the issuer can only purchase certain quantity of bonds periodically with sinking fund provision.

2) Call option’s call price is higher than the face value of the bond but the sinking fund price would equal to either the face value or the current market price whichever is less. So when an investor sells the bonds back to the issuer with call price, he/she gets higher amount than what would come at the maturity. On the other side if the redemption of bonds take place because of sinking fund provision then the price is either the face value price or the current market price if it is lower than the face value.

3) Bonds with sinking fund provision are safer for the investor if something goes wrong with the issuer financially. Because in that case the bonds may become junk bonds or the issuer may even default (failure to pay) and the investor’s investment may be at risk. On the other side the periodic sinking fund provision purchase will make the risk of default lesser even though it cannot avoid it completely.

Further resources

1) What are Bonds?
2) Bond Terminology
3) Bond Yield and Yield to Maturity
4) Bond and Inflation
5) Bond Risks
6) Investment in Bonds

Bond Terminology

September 30, 2012 in Bond, Investing

Now when we have covered the basics i.e. “What are Bonds”, before we move further, let us try to see what are the common Bond terminologies or common terms related to bonds.

Basically if we see the complete cycle it is as follows:

1) Purchase the bonds when those are issued.
2) Get the yearly fixed interest rates.
3) If you wish to resale the bonds before the maturity period then you sale those at the current market value and if not then
4) Wait for the maturity date and trade it back for your initial amount paid.
5) But during this complete cycle you would like to keep an eye on the following:

• How much risk is associate with your bond i.e. risk about getting your initial investment back or who the bonds are rated as far as risk is concerned.
• What are the real returns on your investment. This is true for both cases i.e. whether you had purchased the bond during the initial offering or are going to purchase already issued bonds from the secondary market.

Now more or less we have seen all stages of the life cycle of the bond. The terminology related to bonds will nothing but representing all stages or all entities and are as follows:

Bond Terminology

 Terminology Related to Bonds

  • Issuer: Entity which issues the Bond.
  • Face Value or Par Value: The initial offering price or the price at which bonds are offered at the time of issue.
  • Interest Rate on the Bond: The interest rate committed by the Issuer.
  • Coupon or Coupon Value: The actual amount which you receive as interest. Let us say that the bond face value is USD 5000 and Interest is 10% then the yearly Coupon is USD 500.
  • Maturity: It is the end date of that bond’s life cycle i.e. when the investor gets his initial invested money back.
  • Bond Rating: This is the rating of the issuer to see how safe or risky is the investment. There are major credit rating agencies which evaluate the ratings of the companies or even the governments on regular basis. We will check about these major rating agencies in the later posts. We will check upon the bond ratings in a later post.
  • Yield: As we have seen that the bonds are resalable before their maturity date. Depending on the various economic factors the market price of the bonds can go higher than the initial price or can go low. Yield is nothing but a measure to see the real or net returns on our investment. so yield is returns divided by investment or Coupon Value Divided by The Bond Price at that time. Yield = (Coupon Value)/(Bond Market Price).
  • Junk Bonds: If the credit rating of the issuer goes so low that the risk is considered very high then the status of bonds become Junk bond as your initial investment is in risk. Please note that even such bonds are traded as speculation if the yield on those is very high i.e. the bond market price is very low.
  • Yield to maturity: If you hold the bonds till the maturity date then what are the total returns divided by the bond purchase price is Yield to maturity. In other words your profit amount till maturity date divided by the bond purchase price or total profit till maturity date.

You may also check:

You may also check:

1) What are Bonds?
2) Types of Bonds
3) Bond Yield and Yield to Maturity
4) Bond and Inflation
5) Bond Risks
6) Investment in Bonds

What Are Bonds?

September 27, 2012 in Bond

This question i.e. “What are bonds” started popping up a lot recently from people who have not been exposed to bonds. Who says that crisis situations do not have any positive side? The debt crisis in Greece and Spain etc and ECB’s plans for unlimited bond purchase has been the reason that the otherwise not so exciting term “Bond” started floating everywhere. And suddenly people who have not paid much attention towards the concept, started learning about it.

Let’s try to see what are bonds and not only the concepts but the related terms and how they work.

Concepts of Bond:

Simply speaking bonds are a way to borrow money. Unlike stocks bonds do not make you a shareholder in what operations we do with that money or how we use it.

Now the question would come that why someone would give us money if we want to borrow it? The answer is that there he, she or it will expect some returns for the money lent. The returns offered against the bonds are fixed annual interest. To make the bonds attractive the interest rate would be higher than the normal interest rates offered by banks etc. Because the returns are only interest rate and hence the bonds fall into the category of “Fixed income” investment tools and hence are also called Fixed Income Securities”.

When economies are bullish financial instruments like stocks give much better returns but when risk appetite is low and there is a need for safer investments with surer returns then Bonds are the James Bond.

Bonds Bond

Who Issues the Bonds:

Again simply speaking who wants large amounts of money. But then doesn’t everyone wants it? Well, bonds can be Government Bonds, issued by governments who wish to raise money or Corporate Bonds issued by corporations who wish to raise money for their operations. Corporations can float stocks also but stocks make the investors share holders in the company while bonds do not and unlike stocks, bonds only promise fixed and predefined income i.e. fixed interest.

We have mentioned above that bonds are fixed income securities i.e. pay a fixed income per year by way of interest but we should also add that bonds have a predefined fixed period also. After any money has to be borrowed for certain period of time. So bonds are issued for a certain time with a certain amount of annual returns which are generally paid semi-annually i.e. 2 times a year.

What Happens After the Fixed Period of Bonds is over:

This fixed period is called maturity period. Once this is over then you return the bonds at their initial value to the issuer and get your initial purchase or lent amount back. Your profit was all the interest earned during the purchase period and up to the maturity period.

What If I Need The Money Before The Maturity Period:

You may wish to get rid of the bond because you wish to spend money elsewhere or whatever other reasons. The bonds are always resalable and you can sell those at the current market value. We will touch upon the value part in the later posts.

You may also check:

You may also check:

1) Types of Bonds
2) Bond Terminology
3) Bond Yield and Yield to Maturity
4) Bond and Inflation
4) Bond Risks
6) Investment in Bonds