Bonds are essentially debt instruments that corporations and governments use to raise money. When an entity issues a bond, it is essentially borrowing money from investors and agreeing to repay the loan over a specific period with interest.
Governments and corporations often issue bonds to raise capital. When a bond is issued, the issuer typically agrees to make periodic interest payments to the bondholders and repay the principal amount of the bond when it matures.
There are two types of bonds – fixed-rate or variable-rate bonds. Fixed-rate bonds have coupon payments that remain constant over the bond’s life, while variable-rate bonds have coupon payments that fluctuate based on market interest rates.
Investors purchase bonds to receive regular interest payments and to diversify their portfolios. When bonds are purchased, the investor is effectively lending money to the bond issuer and is entitled to receive periodic interest payments as well as the return of the principal amount when the bond matures.
Bonds are often traded on secondary markets, such as the bond market, where investors can buy and sell bonds that have been previously issued. The current market interest rates and the bond issuer’s creditworthiness determine the bonds’ prices on secondary markets.
5 Things to know about Bonds
1. SIFMA estimates the global bond market (total debt outstanding) to be $119 trillion and the US market to be $46 trillion.
Professionals, pensions, and financial advisors usually invest in bond markets.
2. Bonds are less correlated with stock prices than stocks are, making them a good diversifier for investment portfolios.
3. Credit and interest rate risks are the most significant risks associated with holding bonds. An issuer who does not repay the bond’s debt may default.
4. Bond prices are less volatile than stock prices. Primarily, interest rate changes can impact a bond’s worth more than other market conditions.
5. Standard and Poor’s and Moody’s are two of the most well-known bond rating agencies. The highest AAA rating is the same across all three, but the lowest credit rating is C or D, depending on the agency. The top four ratings are considered safe or investment grade, whereas junk or high-yield bonds are those with BBB or lower ratings from S&P or Baa3 from Moody’s.
Frequently Asked Questions (FAQs)
All types of bonds, such as municipal, government, and corporate bonds, pay fixed payments periodically as coupon payments. Because the return payment on the investment is fixed, bonds are called fixed income.
Bond investors receive periodic interest payments until the bond gets matures. On the maturity date, the issuer of the bond pays back the bond’s face value, and that’s how bonds get paid.
Savings bond takes 30 years to mature. These are secured as government-backed savings bonds, and the issuer makes periodic interest payments until it matures.
Bonds are good for those looking for a stable cash flow and less volatile security than equities. Bonds also tend to fetch better yields than any money market instruments.
There are 5 primary types of bonds based on objectives and risk vs return. The 5 types of bonds are:
1. Savings bond: Savings bonds are government-backed fixed income security that earns regular cash flow until it matures.
2. Municipal bond: Municipal bonds are issued by cities, states, countries and other government entities. Short-term municipal bonds mature in one to three years, and the maturity for long-term municipal bonds is more than 10 years.
3. Treasury bond: Treasury bonds (also known as T-bonds) are issued by the U.S. government. The U. S. government issues treasury bonds to borrow money from the citizens and pays interest. The investors of treasury bonds get back the face value when the bonds mature.
4. Agency bond: Agency bonds are not issued by the U.S. treasury but by a government-sponsored enterprise or the federal government. Agency bonds are considered one of the safest investments due to low risk and high liquidity.
5. Corporate bond: Corporations/Business entities issue corporate bonds to raise capital for their business needs. Corporate bonds pay pre-determined interest in return in the form of a fixed or variable rate.