Bonds Aren’t All That Complex
A Bond is simply a loan taken out by a company/government. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest coupon (the annual interest rate paid on a bond) expressed as a percentage of the face value.
Despite the numerous titles used to describe them; fixed-income securities, debt instruments or credit securities, bonds are nothing more than IOUs in which the terms, pay-back date, and interest rate are carefully spelt out in a legal document. Don’t be discouraged. Bonds are neither as mysterious nor confusing as they may appear.
As you learn about the world of bond investing, here are 8 facts you should know about bonds.
1.When you purchase a bond, you are in effect making a loan to the bond’s issuer, who pays you interest for the use of your money, then returns your money when the bond reaches maturity (you could consider this the expiration date).
2. Bonds Move Opposite to Interest Rates: When interest rates rise, bond prices fall, and vice versa. If you buy a bond and hold it until it matures, swings in interest rates and the resulting swings in the bond’s price won’t matter.
3. Bonds Have Yield Curves: The key to understanding the bond market lies in understanding a financial concept called a yield curve, which is a graphical representation of the relationship between the interest rate that a bond pays and when that bond matures. Once you learn to read curves, you can make informed comparisons between bond issues.
4. Just like shares, you can trade your bonds in the secondary market, if you do not want to wait till maturity to get your money back.
5. Bond issuers (Government and corporate entities) typically attach a coupon to the Bonds. A coupon is the interest paid on the bond. For example, FG issues a bond of N10b at a coupon of 6% per annum. What they mean is they want to borrow N10b from the public and are willing to pay 6% interest per annum for 10 years.
6. Bond price is issued at either N100 or N1000 (Par) at the initial auction which is called the primary market.
7. Just like shares, there is an upward or downward movement in bond price after the initial auction in the secondary market depending on economic factors. You can either buy at a discount i.e. < par or premium > par.
8. Whilst both shares & bonds are investment securities they are different. Owners of shares are equity holders, whilst owners of bonds are debt holders.
Types of Bonds
- Sovereign Bonds: Bonds issued by the federal government. to finance its capital expenditures which include the construction of roads, bridges, schools, hospitals etc.
- Sub-national Bonds: Bonds issued by states and local governments to finance their capital expenditures which include the construction of roads, schools, hospitals etc.
- Corporate Bonds: Bonds issued by companies to raise capital to improve their businesses.
- Asset-Backed Securities: Bonds backed by financial assets. Here, assets are bundled together and resold to investors as bonds.
Corporate bonds have more credit risks than Sovereign bonds and Sub-national bonds because defaults are rare in Sovereign bonds, few defaults in Sub-national but defaults happen regularly in Corporate bonds. In investment and finance, the safer an asset, the lower the yields.
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