Detailed Explanation About Bonds

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Do you know what bonds are? you might or you might not know about what are exactly bonds. Hopefully, by the end of this blog, you will know the basics of bonds, their types, etc.

What’s in it for you

  1. BONDS
  2. HOW TO ISSUE?
  3. MERITS AND DEMERITS OF BONDS
  4. DIFFERENT CATEGORIES
  5. VARIOUS VARIETIES
  6. CONCLUSION
  7. FREQUENTLY ASKED QUESTIONS (FAQ)

BONDS

Bonds are the instrument that the government uses for raising funds from the market. It specifies all the details related to the lending of money by the investor.

All those who issue these in the market turn to be the borrowers. They pay interest to the investors. Investors usually get a fixed amount of interest (coupon), but now interest sometimes fluctuates according to the terms and conditions at the time of the issue.

Bond prices are inverse to the interest rates when the interest rates increase price falls whereas when the interest rate falls the prices rise.

At the time of maturity date, there is repayment of the principal amount or there is a risk default.

Government and various other corporations use these for raising funds.

The government requires the fund to fulfill the need for money required to invest in infrastructure and other facilities for citizen’s welfare.

Various corporations need money for different activities of the organization.

The financial needs of these corporations can not be met simply by borrowing money from banks and hence they issue money from the public through this source.

HOW TO ISSUE?

money-hand-certificate
How are bonds issued?

Bond’s other name is Fixed-income Securities. Whenever companies or governments are in need of the money they issue these to collect money. This already includes the loan terms, interest rate, maturity date, etc.

Interest is paid on the principal amount spent by then bondholders to buy a bond.

This interest is also called as coupon interest, at maturity the principal amount paid back along with the interest.

Now, when these start to float in the market there initial price is usually at par(Face Value)per bond.

The current price of the bond depends upon the following things → 

I. The credit quality of the issuer.

II. Length of time until expiration.

III. Coupon rate compared to the general interest rate environment at the time. 

Most of these securities can be resold by the investors (bondholders), it is not necessary for them to retain these until maturity. The borrower can even repurchase these and again sell them at a new lower cost or adjusted interest rate.

FEATURES/CHARACTERISTICS

There are various characteristics some of them are as follows →

REPAYMENT OF PRINCIPAL→ There is repayment of the principal amount to the investor at the time of maturity.

SPECIFIC TIME PERIOD → These carry a specific maturity date that is mentioned at the time of the issue.

These are issued for long term as well as short term.

On the maturity date the investors get back their initial amount.

CALL → These have an additional feature of call, which means the borrower company can buy back its bonds anytime it wants and these may or may not be reissued at revised interest rates etc.

Usually companies buy back their shares at a value slightly higher than its face value. 

 Eg. the face value of your bond is 1000 and you give Rs 70 as interest per year then you would buy shares at Rs. 1050 or any other value, slightly above the par value.

PLEDGE OF SECURITY → Pledge of security means to mortgage any asset as security to the investors.

This is done in writing along with signatures and underseal and is kept with the trustee.

Any deal without a  written mortgage is not considered as a pledge of security.

INTEREST

Interest is paid to the bondholders regularly, usually at a fixed rate of interest. This rate of interest is called as ‘Coupon Rate’.

MERITS AND DEMERITS OF BONDS

bonds
merits and demerits of bonds

SOME MERITS →

  • FIXED INVESTMENT RETURNS –>

You attain a fixed rate of return and get back your principal amount after the maturity period ends, hence you have a clear image of what amount will you earn from this investment

  • LESS RISKY COMPARED TO STOCKS → 

Investing here is less risky as compared to stocks as the stock market as it is highly uncertain whereas you can have a rough idea of your earning through prior to investment.

  • VOLATILE  → 

These are highly volatile and the value increases and decreases due to inflation and current interests but still these are more stable than the stock market.

DEMERITS →

  1. FIXED INVESTMENT RETURNS → 

On the one hand, it is safe to invest here but it gives you less chance to earn higher profits and take the risk, you earn a fixed minimum amount of money.

  1. LARGER SUM OF INVESTMENT NEEDED → 

Usually, these are costly and do not fit the range of huge no of ordinary buyers.

     3. LESS LIQUID COMPARED TO STOCKS → 

Generally, bonds of US corporations and other big companies are highly liquid. But on the contrary bonds of small companies are not easy to sell and hence are less liquid.

DIFFERENT CATEGORIES

invest.
Various categories of bonds to invest.

CORPORATE BONDS Companies issue these funds to raise funds from markets.

Usually, companies prefer to issue these rather than taking loans from the bank as these take a lower rate of interest and other terms are also suitable.

AGENCY BONDS → The source of their issue is government-affiliated sites.

MUNICIPAL BONDS → States and municipalities issue them. Some municipal offices give tax-free coupon income for investors.

GOVERNMENT BONDS → US treasury issues them, these are short term financial instrument and get expired within 1 year’s time, these are called ‘bills’.

Whereas those which have a time period of issue between 1-10 years called ‘notes’, those issued more than 10 years to maturity are called ‘bonds’.

The complete category issued by government is “treasuries.”

VARIOUS VARIETIES

bonds varieties
Bonds varieties

There are various different types of bonds some of which are → 

1>  Zero-Coupon Bonds These do not pay coupon payment but these are issued at discounted price even less than the par value. later the bondholder is paid the full face value and hence he makes profits. The US treasury bill is also called as Zero Coupon Bond.

2> Convertible Bonds → These are the ones that can be converted into equity shares at the time of maturity .

Usually, these are issued at a comparatively less coupon rate as compared to general ones as they give the investor the ability to convert them into equity.

Eg. the coupon rate is 14%

Now the company gets to know that some investors are interested at a less interest rate along with the ability to convert into equity. then this company issued convertible ones at 9% interest rate along.

3> Callable bonds These are the ones that can be called back by the company whenever it wants. These are beneficial for any company as it is in there hands to take these whenever they want them back.

They can repurchase the issued ones and later after any required revision like alteration of interest rate etc, can be done and these can be reissued by the company.

4> Puttable bonds → These allow the bondholders to put or sell theirs before the maturity of the bonds.

This is important for investors who fear the risk of high-interest rates or the ones who fear that the value of the bond will fall they can easily seel off these and get their principal amount back.

CONCLUSION

conclusion

Bonds are the instrument that the government uses for raising funds from the market. It specifies all the details related to the lending of money by the investor.

FEATURES/CHARACTERISTICS OF BONDS

1>REPAYMENT OF PRINCIPAL

2>SPECIFIC TIME PERIOD ETC.

MERITS →

1. FIXED INVESTMENT RETURNS  

2.LESS RISKY COMPARED TO STOCKS

3.VOLATILE   

DEMERITS →

  1. FIXED INVESTMENT RETURNS
  1. LARGER SUM OF INVESTMENT NEEDED

     3. LESS LIQUID COMPARED TO STOCKS

CATEGORIES OF BONDS

CORPORATE BONDS Companies issue these funds to raise funds from markets.

AGENCY BONDS → The source of their issue is government-affiliated sites.

MUNICIPAL BONDS → States and municipalities issue them. Some municipal offices give tax-free coupon income for investors.

GOVERNMENT BONDS → US treasury issues them, these are short term financial instrument and get expired within 1 year’s time, these are called ‘bills’.

DIFFERENT VARIETIES OF BONDS

There are various different categories of bonds some of them are discussed above.

ALSO READ MY BLOG – EVERYTHING ABOUT TRADING IN STOCKS?

FREQUENTLY ASKED QUESTIONS (FAQ)

How do bonds work?

Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you’re giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest opens a layer-layer closed payments along the way, usually twice a year.

Are bonds safe?

In times of economic instability, bonds and other debt instruments issued by the U.S. Treasury are considered extremely safe because the risk of the U.S. government defaulting on its financial obligations is minimal

Do bonds pay dividends?

When you buy a bond, you are lending money to a company or government entity. In exchange, the borrower agrees to pay you a fixed rate of interest, known as a bond dividend

Which is the safest type of bonds?

The Safest Bonds
Treasury bonds are sold by the federal government. Because they are backed by Uncle Sam, Treasurys have practically no default risk and are the safest bonds to buy.

Which is the most riskiest type of bond?

Corporate bonds: Bonds issued by for-profit companies are riskier than government bonds but tend to compensate for that added risk by paying higher rates of interest.

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