A bond is a financial product that permits an investor to lend money to an issuing entity. In exchange for holding a bond, the lender receives a payment of interest, also called nominal interest. Simply put, it is a form of borrowing. The buyer of a bond is, by definition, the lender, while the issuer is the borrower. The issuance of bonds is a practice that allows entities to finance themselves. The money a company receives from issued bonds is considered a loan. In general, it must be returned after a period of time on a previously agreed-upon date. Until that date, the bondholder (the lender) receives the interest payment. Issuing entities can be corporations, cities, or even national governments.
What should you know about bonds?
There are three key elements of a bond that are important to understand well: coupon, par value, and maturity date.
Coupon: The coupon (or nominal interest) is the interest rate paid by the issuer of a bond. For example, a $1,000 bond with a coupon of 5% per year will pay $50 per year. The term “coupon” comes from a time when bonds had a paper coupon attached that could be redeemed for payment.
Par Value (Facial): Par value is the face value of a bond. Also known as face value. This is the amount paid to the holder of the bond at its maturity. If the interest rate increases above the nominal interest rate, the bond will be redeemed below parity. If the interest rate falls below the nominal interest rate, the bond will be exchanged at a premium, that is, above parity.
Expiration date: This is the agreed-upon date on which the bond must be reimbursed. As a general rule, bonds are considered low-risk products. Interest payments and maturity dates are pre-fixed, making it a stable and predictable source of income. The exceptions to this principle are when the bond is not held to maturity or if the issuing party declares bankruptcy.
Who issues the bonds?
Despite the fact that there are several entities that may issue bonds, a preferred distinction is made between the forms of issuers:
State bonus.
States often issue bonds to generate money to finance the costs of roads, schools, bridges, or other infrastructure. In some countries, the expense of an unforeseen war may also create the need to raise funds. Bonds often have maturities of ten or more years and are considered long-term investments.
Corporate bonds.
Corporate bonds are issued by companies to allow their businesses to grow. By issuing them, companies can buy real estate and equipment and undertake lucrative projects. Extra income can also be used for research and development or to hire staff. In some cases, companies need more money than a typical bank can lend, and bonds can solve this problem by allowing many individual investors to lend money. Corporate debt can range from extremely safe to extremely risky.
There are four different types of bonuses.
Apart from the various issuers, there are different types of bonds depending on their characteristics. The four most common types are:
Perpetuity bonds.
These bonds do not have a fixed maturity date, and there is a possibility that they will not be reimbursed.
Convertible bonds.
Under certain conditions, these bonds can be converted into shares of the company.
Pay with floating interest.
These bonds have a variable interest rate.
Subordinated bonds.
In the event that the issuing entity goes bankrupt, these bonds will only be redeemed once all other bonds owed have been redeemed. Therefore, the risks and benefits are relatively high.
How to buy bonds
The most common way to buy bonds is through a broker, and purchase commissions vary from one broker to another. With DEGIRO, you can buy government and corporate bonds online in a large number of markets, with a transaction fee that depends on the bond market. Unlike other financial instruments, the price of bonds is not set in currency but rather as a percentage of the parity value. This makes it less complicated to calculate the effective hobby fee.
What determines the price of a bond?
The price at which a bond is bought or sold can depend on many factors. Although the coupon and face value are constant, the value of the bond can change. These are the main factors that can influence the value of a bond.