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Bonds

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Bonds

For companies and governments, a very common way is to issue Bonds to finance some projects and operations. An issuer offers interest (coupon) as a monthly payment to a lender and repays the principal (face value) at the maturity date.

So, a bond is like a form of a loan, where an issuer is a borrower and a bondholder is a lender. The bond agreement includes the end date when the principal of the loan should be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.

Bonds can be issued by governments or by corporations. This is a very common way of raising capital. Governments mostly need funds for infrastructures, roads, schools, etc. What about corporations? They use these funds to grow their business, buy assets or start some new projects. A bond provides many individuals with the opportunity to be involved in the investing process.

Bond’s coupon rate (interest rate) mostly depends on two features – credit rating of issuer and time of maturity. A poor credit rating is a risky investment, it means the risk of default is bigger than usual, so this bond issuer will pay more interest. Also, the interest rate is higher when the bond has a long maturity date. This is also explained by inflation risk in the future bond market.

Bonds

Categories of Bonds

There are four primary categories of bonds sold in the markets.

Government bonds  – Treasury bonds are issued by the national government.

Such type of bond is not exposed to default risk. It is known as the safest bond, with the lowest interest rate.  

 Bonds issued by the Treasury with a year or less to maturity are called “Bills”; bonds issued with 1 – 10 years to maturity are called “notes”; and bonds issued with more than 10 years to maturity are called “bonds”.

The entire category of bonds issued by a government treasury is often collectively referred to as “treasuries.”
Municipal bonds  are issued by states and municipalities.

 Some municipal bonds offer tax-free coupon income for investors. They return a little more than Treasuries but are a bit riskier. 
Corporate bonds are issued by companies.

They have more risk than government bonds because corporations cannot raise taxes to pay for the bonds. The risk and return depend on how credit-worthy the company is.

The highest paying and the highest risky ones are called junk bonds.

Varieties of Bonds

Bonds can be separated by rate, type of interest, coupon payment, etc.

Zero-coupon bonds 

known as Zeros.

 Do not pay coupon payments.

Such bonds are issued at a discount. So that will generate a return once the holder is paid the full-face value when the bond matures.

Treasury bills are a zero-coupon bond.
Convertible bonds allow holders to convert their bonds into stock (equity). These are known as hybrid securities because they combine equity and debt features.

For issuer company and for investors, such type of bonds has its own advantages– issuer will have lower interest payment. What about investors? They can get a profit if the project is successful.
Callable bonds can be “called” back by the company before it matures.

 Such a bond is very privileged for the issuer because if interest rate gets lower (company improves credit rating) before maturity time, they can call or buy the bonds back from holders for the principal amount. After that, the company can reissue new bonds at a lower coupon rate. 

 A callable bond is riskier for the bond buyer.
A Puttable bond  allows the holders to put or sell the bond back to the company before it has matured.

 

This is valuable for investors who are worried that a bond may fall in value.
Asset-backed securities  are bonds whose interest and principal payments are backed by assets.

 Examples of asset-backed securities are mortgage-backed securities (MBSs), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs).

Bonds structure is really various and each side – issuer or investor – can choose the bond that is more suitable for them.
As a conclusion, the bonds market plays a huge role in economic development and has many advantages. One of the main advantages of the bond market is that bonds can be paid off in two ways:
1. To receive income through interest payments. Also very safe is to hold bonds to maturity, while getting principal back.
2. The bondholder can resell bonds at a higher price than buying it on the second market.
Bonds as investments are less risky than stocks. So, compared with them, these offer less return (yield) on investment. A bond buyer should make sure that the issuer is backed by good credit ratings.

Bonds

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