In this article, we will discuss what bonds are and for that let us first understand the meaning of the bond. The definition goes this way, the bond is a fixed income security which allows a lender to lend a predetermined amount of funds and be eligible for interest on those funds. Bonds are some of the most necessary and fundamental vehicles in the financial sector. They allow towns, governments, companies and other groups to get funding. Bonds are essentially just IOUs to the person giving you money, the lender, that says you’re going to pay them back sometime in the future. They’re a fancy form of a loan that gets companies and governments funding when they need it.
There is something that makes bonds differ from loans and that is, they are a form of a security, and in that you can buy a bond and start getting payments from the company that owes you. In essence bonds are securitized loans. Bonds will typically include an end date in their terms when the entire amount of money is due back to the issuer as well as terms for the interest payments to be made.
There are some core principles about bonds to remember if you’re looking for a general overview and they are as follows,
Bonds are corporate or government debt issued by an organization that are tradable assets in the form of securities. Bonds are stable and referred to as a fixed income instrument. Their payments to holders don’t fluctuate over time like the value of stocks or dividend payouts do. Bond prices inversely correlate with interest rates. Since a low interest rate usually means the borrower is trustworthy, more people will want to own that bond because there’s little risk. Conversely high interest rates infer a risky borrower, which increases the chance that a bond will become worthless, thus making them cheaper. Bonds have dates at which point all of their value must be paid back. This is called the maturity date, and beyond this point the bond ceases to exist.
As we mentioned before, bonds are a way for companies or governments to raise money without giving up ownership of their company, which is what selling stock would do. If a government needed money for a project, they could issue bonds which investors can buy and be guaranteed payments by the government. Government bonds are typically seen as safe because there’s little chance the government won’t pay back the funds. Companies, on the other hand, go bankrupt far more often, which would mean, any bonds they have issued would become worthless. If companies like Apple issued a bond, investors would eat it up because it would be seen as a very safe investment. However, if another company like a blockbuster issued a bond to raise funds to open up a new store, it would be a pretty risky bond.
You might be getting this question in your mind, why wouldn’t a company just go to a bank and get a loan. Well, chances are that the bank can’t loan them the amount of money they need. So, in this case companies have to turn to selling bonds to raise more capital. Bonds provide a way for individual investors and funds to become lenders to massive companies. Think of it almost as a way of crowdfunding corporate or government debt. Finding one bank to give you 20 million dollars might be hard, but finding 20,000 people to give you 1,000 would be a lot easier.
To know more about them, Bonds are a form of security just like stocks, except bonds are generally more secure and offer payments over time and have an end date, which is how investors make their money rather than buying the stock at one price and selling it higher later. Bonds can be traded publicly or privately depending upon the way that they’re set up. While you might buy a bond in a similar way as a stock, the difference is that bonds will come with terms and a plan for how and when you’re going to get your money back. Bonds will include the terms of the loan, the interest payments to be made over time, and the maturity date (the time at which the entirety of the funds need to be paid back to investors).
Bondholders make their money through interest payments that the company makes to them, on top of paying back the original loan. Interest payments are called the coupon and the rate of interest is called the coupon rate. Most bonds are usually priced at either one hundred or one thousand dollars and it is called the par value. However, prices can fluctuate from time to time as people buy and sell them. When a company issues a bond when their financials are at a good level, but then something drastic happens, like a pandemic and suddenly the company loses all their revenue, the bond will fall as people wouldn’t want to own or have it. However, since the bond was already sold to investors, in this case it would be the investors who lose their money, not the company who issued the bond. So, this is the same way stocks and other securities work, it has the risk of investing.
The value of a bond depends on the main factors such as credit quality of the issuer, date until maturity and the coupon rate compared to the average interest rate of other bonds. You could buy a bond and never plan to hold it until maturity, rather you could buy a bond to just flip it a few weeks later if the price went up.
To emphasize more, there are following things too, face value is the amount of money the bond is worth at maturity. A face value of dollar 1,000 would mean that at the maturity date, the issuing company would have to pay you back the full dollar 1000. The coupon rate is the interest rate which the issuer will pay. A five percent rate on a one-thousand-dollar face value would mean that you’d get fifty dollars per year in addition to the one thousand dollars at maturity. Coupon dates are the dates when interest payments will be made. And the maturity date is the end date of the bond and finally the issue price is the initial price the issuer set to buy the bond from them.
Hope we were helpful and have cleared all your queries related to the bonds in this article.