A bond is debt security quoted on a recognised stock market and issued by an organisation seeking to raise financing to mainly expand the business and accelerate profit.
The bond issuer is the borrower/debtor and the person who lends money is the creditor/bondholder.
There are 4 main features of bonds:
- Who issues them.
- The length until maturity.
- The quoted interest rate.
- The risk rating.
Government bonds are issued by countries. The more stable and solid rating of the country the lower interest they propose to the debt holder.
Municipal bonds are issued by cities and localities. Their return quite often is higher than countries but also has a higher risk rating.
Corporate bonds are issued by companies. They have more risk than government bonds because corporations do not have such resources and can’t raise taxes to pay for the bonds.
The debtor promises to pay the bond back at an agreed-upon date, called maturity.
Until then, the debtor makes agreed upon interest payments, which are called coupons, to the debt holders.
When the bond matures, the debtor pays the debt holder back the original amount borrowed. The capital amount of the bond debt always returns to 100% at maturity, while during the term of the bond it will trade either up or down from it’s original launched price.
Bonds as investments are:
- Less risky than stocks, so this offers less return (yield) on investments.
- Can be traded before maturity for a higher price.
- The risk and return rating depends on the credit worthiness of the organisation.
- They are a fixed-income investment.