Bonds

Over the years, bonds have been a go-to investment option for both conservative investors and individuals with low-risk appetite. They serve as a fixed investment avenue for individuals and allow them to generate revenue, without being exposed to too many risks.

Nonetheless, to maximise the benefits of these investment options, individuals must become familiar with the various aspects of bonds.

What Are Bonds?

Typically, bonds are high-security investment instruments and belong to the category of debt. With the help of bonds, borrowers like corporate organisations or the government raise funds from investments for a given period. 

The fact that they yield a fixed or variable interest to investors, makes them a fixed income investment instrument. On maturity, borrowers receive the principal or par value of the bond. Ideally, bondholders receive debt recovery payouts before the stockholders of a company. One must note that the bond value of a company tends to change over time. Also, bonds that are high in terms of quality offer a low rate of interest. 

Types Of Bonds: 

This table below highlights the features of different types of bonds.

Types Of Bonds 

Description 

Government bonds

These fixed-income investment instruments are generally classified based on their maturity period. They are available in 3 distinct types –

    1. Bills – They come with a maturity period of less than a year.
    2. Notes – They come with a maturity period of less than a decade.
  • Bonds – They usually have a maturity period of over 10 years.

They are among the least risky bonds.

Municipal bonds 

When compared to government bonds, these are relatively risky. However, they prove useful in generating more yields. 

Corporate bonds

Companies issue these bonds. The organisation determines the time of issuance and number of bonds to be issued. The accompanying risks depend on the issuing company’s credit profile. 

Zero-coupon bonds

These bonds are issued at a discounted rate and do not offer any interest to the investors. They are also known as strip bonds as they are stripped of interest payouts. 

Bond derivative 

These bonds are priced concerning the expected price of an underlying bond index or bond. 

Besides these, another noteworthy fixed-income bond is a convertible bond. These bonds allow investors to get them converted into equities. However, such a conversion is bound by certain circumstances, including share price. 

Characteristics Of Bonds:

The most noteworthy characteristics of bonds are discussed below –

  • Coupon Rate:

Ideally, factors like bonds’ creditworthiness and maturity period are weighed in to determine their coupon or interest rate. One must note that bonds with faltering credit quality usually offer higher interest to bondholders.

  • Coupon Date:

It is the date on which issuers decide to payout interest to investors. While the coupon date is determined as per issuer’s discretion, the standard payout is made semi-annually. 

  • Face Value:

It indicates the sum of money that the bond will amount to on its maturity date. Usually, the face value of a bond serves as a reference point to compute interest payouts.

  • Price Of Issuance: 

Generally, governments, municipalities, companies, and authorised bodies can issue bonds. The issuance price denotes the amount at which organisations can issue bonds to investors.

  • Risk Factor:

Being a debt instrument, the risk factor associated with bonds is relatively low when pitted against equities. Nonetheless, bonds are not entirely risk-free, and they expose individuals to threats like – interest risk, reinvestment risk, default risk, and risk of inflation. 

  • Maturity Date:

It is a predetermined date on which a said bond will mature, and investors will receive its face value from the issuer. Typically, the maturity date of bonds can range from 1 day to 30 years.

Apart from becoming familiar with the features and types of bonds, individuals should find out how bonds work in general. This will help investors effectively understand their functionality and more. 

How Do Bonds Work?

Bonds work on an agreement, and they are traded publicly on exchanges. However, they can also be sold privately between an issuer and an investor. 

Essentially, the borrowing organisation promises the bond buyer or investors to pay back the bond value at a pre-fixed date. Until the maturity date, the borrower pays interest at a fixed rate to the bondholders. 

When the bond matures, the debtor or issuer pays the principal amount to the creditor or bondholder. However, individuals can resell their bonds before it matures. This also influences the value of the bonds throughout until its maturity.

Nonetheless, before investing in bonds, individuals should consider a few factors. For instance, they should identify their risk appetite and financial goals. Subsequently, they should analyse what time horizon will help them to meet their financial goal easily. Lastly, they should determine the ideal mix of debt and equity instruments in their portfolio before investing in bonds.