everything about bonds

 

Many investors know that bonds are for investing. But that’s about it — more details are not known.

This post, we’ll cover everything about bonds.

Bonds are essentially loans.

A borrower takes a loan from a lender.

The lender has given money to the borrower. In return, the borrower gives a certificate to the lender.

The certificate mentions the amount borrowed, the interest rate, and the time period.

When the time period is over, the lender will take the certificate to the borrower and ask for money + interest. And the borrower will give him the money back plus interest.

This certificate is called a bond.

So we know what bonds are.

An interesting aspect of bonds is that they’re tradable.

If you have a bond, you can sell it to someone else. When the time comes for the borrower to pay back the money, they will simply pay it back to whoever has the bond.

It is not necessary that the money is paid only to the original lender.

This allows lenders to get money for their bonds much earlier than they are supposed to.

The laws of demand and supply also play a role. Which means, if you are desperate to sell your bonds, you might have to sell at a price lower than what the bond would fetch upon maturity.

The opposite can also happen: you can sell it for more than its worth if buyers are desperate for it.

There are a few types of bonds:

Fixed-rate bonds: the interest rate is fixed in this case.

Floating-rate bonds: the interest rate can change from time to time.

Government bonds: these are offered by governments and usually offer low interest rates. They are considered low-risk. They can offer fixed or floating rates. There are a few subcategories of these.

Corporate bonds: these are offered by private companies and offer varying levels of interest starting from low to high. The risk level of these bonds also varies though generally, they are considered riskier than government bonds.

Tax-saving bonds: these are offered by the government to help save tax. Again, they are usually low-risk and offer lower returns.

Bank bonds: these are bonds offered by various banks. These bonds’ risk and interest rates can vary too.

Terms related to bonds:

Maturity: is the period after which the borrower pays back the borrowed money.

Secured bond: if the bond is backed by collateral, it is called a secured bond. If it is not backed, it is called unsecured.

Coupon: it is the amount the bond pays to the bondholders. It may be scheduled to be paid monthly, semi-annually, annually, etc.

Callability: this option allows the borrower to pay back the maturity amount and interest a bit earlier than scheduled. Usually, they offer a slightly higher amount of money for paying back early.

Borrowers use this option to mostly close off an existing borrowing and to borrow fresh because they are getting a lower interest rate somewhere else.

Role of agencies.

There are agencies that rate bonds.

The rating is to indicate the risk-level of bonds.

This rating is then used by banks, institutions, and organisations to make buy and sell decisions related to bonds.

Obviously, the rating is never perfect but they try to.

Some ratings agencies are also accused of incompetence because they’ve failed to rate accurately.

Worse, some are blamed for corruption — giving ratings that aren’t deserved. But that’s another story.

If you look at bonds, you will be able to read their ratings.

Usually, highly rated bonds offer lower interests, and poorly rated bonds offer higher interests.