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.
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.
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