What to know about bonds

When you need money, you go to financial institutions to ask for a loan. When businesses or government agencies need a lot of money, they issue the bonds. The first thing that comes to mind when talking about investing is the stock market. It is true that the world of equities is exciting. Market movements are dissected in newspapers and on television.

Bonds, on the other hand, are not as sexy. The jargon surrounding this type of financial product may seem obscure to the uninitiated. In addition, bonds are much more “cushy”, especially during a bull market, when they seem to offer an insignificant return compared to stocks. In this article, we will present to you what a bond is and how you can take advantage of it. But before we begin, here is Monetized his social network experience? Let's go !!

What is a bond?

A bond is a debt security issued by organizations (a company, a local authority or a state). When one of these institutions (state, community or company) wants financing, the amounts they would like to have may require the presence of several creditors.

By purchasing a bond, you can become one of these creditors, in other words, participating in purchasing part of the debt. At maturity, in addition to the capital which will be reimbursed to you, the debtor undertakes periodically to remunerate you (each year, each half-year, each quarter or each month) based on an interest rate that you have set. in advance.

An institution wishes to obtain a loan of 10 million euros. She decides to use a bond loan with a fixed rate. Considering that the sum is huge, she divides this loan into 1 shares of £000 each. That said, any bond issued will cost 10 £. Then, it places the interest rate at 5% over a life of the loan of 10 years.

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If you want one of his bonds, then you have the opportunity to acquire one. So if the remuneration is done every year, you will receive £500 every year for 10 years. In the tenth year, the borrower will reimburse you £500 added to your initial £10. You will therefore have an income of £5000 in total over the 10 years (£500).

Types of bonds

There are several types of bonds which can be differentiated according to the lifespan or according to the terms of payment of the coupon:

Government bonds

Imagine you have a buddy called the State. He needs money to build roads, schools, all that. So he says to you: "Lend me 1000 bucks, and I'll pay you back in 10 years with interest." That's what a government bond is. It's considered super safe, because hey, the State isn't going to run away with your money, right? On the other hand, since it's safe, it doesn't bring in thousands and hundreds either.

It's a bit of a cushy investment for people who don't want to worry. There are short-term, medium-term, long-term bonds... You choose according to your needs. The advantage is that if you need your money before the deadline, you can always resell it on the market. But be careful, depending on which way the wind blows, you can win or lose. It's a bit like a game of poker with the global economy.

Corporate bonds

There, it's as if a big company, like Apple or Total, said to you: "Hey, we have a crazy project, but we need cash. Can you lend us some?" It works like government bonds, except that it's a company that borrows. It's generally considered a little riskier than government bonds, because well, a company can always go bankrupt. But then, it often yields a little more. There are different qualities of corporate bonds.

The best ones are what we call "investment grade"It's a bit like having a grade at school: if you're above average, you're good. Below average, you're in the territory of "junk bonds" or junk bonds. It pays more, but it's riskier. It's a bit like lending money to your friend who always has a revolutionary business idea, but who always ends up asking you to buy him a beer.

Inflation-indexed bonds

So that's the smart thing to avoid getting eaten up by inflation. You know, when everything increases and your 20 euro note is worth next to nothing? Well, these bonds are designed to protect you from that. The principle is that the amount you receive increases with inflation. It's a bit like having a salary that automatically follows the cost of living.

Pretty cool, right? It exists for government and corporate bonds. It's particularly interesting when inflation starts to play up. On the other hand, when inflation is low, it yields less than traditional bonds. It's a bit like insurance: when everything is going well, you tell yourself that it's money thrown out the window, but when things go to hell, you're glad to have it.

Convertible bonds

So this is the Swiss Army knife of bonds. You get the benefits of a traditional bond, but with a little extra surprise. Basically, at some point, you can decide to transform your bond into shares in the company. It's like lending money to a friend who is launching a start-up, and he says to you: "If it works, you can become a shareholder if you want." Pretty cool, right?

If the company is a hit, you can potentially make a nice profit. On the other hand, if it goes belly up, well you still have your bond. It's a bit like the best of both worlds. But be careful, it's not the goose that lays the golden eggs either. It generally yields less than a classic bond at the start, because you have this conversion option. It's a bit like paying for insurance to be able to benefit from the success of the company.

High-yield bonds (or "junk bonds")

We talked about it a little earlier, but let's dig a little deeper. These bonds are a bit like the bad boys of the bond market. They are issued by companies that don't necessarily have a great financial reputation. So, to attract investors, they offer higher interest rates. It's tempting, right? But be careful, there's no miracle: more return = more risk.

It's like lending money to your friend who always has great ideas but always ends up failing. He promises to pay you back double, but you're not sure you'll see your money again. These bonds can be very profitable, but they can also leave you high and dry if the company goes bankrupt. It's a bit of an investing roller coaster.

In terms of obligation, precise terms are used:

• The transmitter. This is the organization or company that sells the bonds.
• face value. it is the price to pay to acquire a bond.
• Interest rate ; this is the rate set by the issuer.
• Deadline ; this is the term of the loan.
• The coupon; this is the interest paid by the borrower. This term comes for the reason that bond certificates sometimes relate to detachable coupons that investors must surrender in exchange for interest. Today, certificates are stored in an electronic register.

The actuarial rate of a bond

This rate makes it possible to compare the profitability of bonds. As an example, a bond of one 5 year term and which offers a 8% coupon is not entirely more advantageous than another 5-year one still with a 5% coupon. SO, the 8% obligation can be expensive and offer a minimal actuarial return. If the 8% bond quotes 115%, it will have a yield to maturity of 4.575% each year.

This corresponds to a performance over a period of 5 years of an investment with an initial investment of 115 euros, which gives you 8 euros per year for 5 years and reimburses you 100 euros at the end. On the other hand, if the 5% bond rates 99%, it will have an actuarial yield of 502%. It is therefore more interesting to invest 99 euros with the aim of receiving 5 euros each year for 5 years and obtain 100 euros at maturity. Thanks to the actuarial rate of a bond, you can compare its return value to other investments.

Advantages of a bond

Okay, let's talk about the benefits of bonds. I'll explain them to you like we're having a beer chat, is that okay?

Safety, buddy

Bonds are a bit like your grandmother's mattress. It's not the most exciting thing in the world, but at least you know where you put your money. Especially for government bonds, it's considered super safe. It's not the kind of investment where you wake up one morning and say "Shit, I lost everything!" Sure, there's always a risk, but compared to stocks that go up and down, it's pretty cushy. It's the choice of people who prefer to sleep soundly rather than dream of a yacht.

Regular income, such as a salary

With bonds, it's a bit like having a second job, except you don't have to do anything. You receive interest regularly, often every six months. It's great for supplementing your income or for paying yourself that little extra you want. Some retirees love it for having a stable income in addition to their pension. It's like having a small part-time job, but without the annoying boss and the crappy hours.

You know where you're going

When you buy a bond, you have a repayment date. It's not like stocks where you never know when it's the right time to sell. Here, it's clear and simple. You know exactly when you're going to get your money back (well, if everything goes well). This is handy when you're planning a big purchase, like a car or a wedding. You can time the end of your bond to coincide with the time you need the money.

The risks of buying a bond

Ah, you want to talk about risks now? Well done, always look at both sides of the coin. Come on, I'll throw this at you like we're at a bar.

The risk of default, or when it smells like a scorch

Imagine you lend some money to your buddy. He swears to you that he'll pay you back, but on the day, poof, he's disappeared into thin air. Well, with bonds, it's the same. If the issuer (the government or the company) goes bankrupt, you're in trouble. You can kiss your beautiful notes goodbye. It's rare for governments (although it happens), but for companies, it's more common. The stronger the issuer is financially, the less risk there is. But hey, even giants can fall, look at Lehman Brothers.

Interest rate risk, or how to be fooled by the weather

That's the tricky thing. You buy a 3-year bond at 10%, all happy. Except that two years later, the rates go up to 5%. And then you look smart with your bond that yields peanuts. If you want to sell it before maturity, you're going to have to lower the price so that someone will buy it back from you. It's like buying the latest iPhone right before the new model comes out. Suddenly, yours isn't worth much.

The risk of inflation, or how your money melts like snow in the sun

Inflation is the bane of savers. If your bond yields 2% per year, but inflation is at 3%, in reality, you lose purchasing power. It's as if you were running on a treadmill that is going faster than you. You make an effort, but you don't move forward. Unless you have taken inflation-indexed bonds, but we've already talked about that.

Liquidity risk, or when you're stuck with your piece of paper

Sometimes you want to sell your bond before maturity. Except no one wants it. It's like trying to sell an expired tuna sandwich. You end up stuck with your bond, unless you sell it at a bargain price. This happens especially with little-known bonds or when the market is choppy.

Currency risk, for adventurers

If you buy a bond in a foreign currency, you have an additional risk. The exchange rate can move and cause you to lose money, even if the bond itself is doing well. It's like playing two games at once: the bond game and the currency game. There you go, buddy. I don't mean to scare you, huh. But as they say, forewarned is forearmed. Or forearmed women, of course. Equality, all that.

Frequently Asked Questions

What is the characteristic of a bond?

You can characterize a bond by its type, denomination, face value, price, term, method of redemption and yield.

What is the difference between a bond and a stock?

A bond is a part of loan emitted by a community a state or a private company, on the other hand a share is a fraction of the capital in a company.

What is the real purpose of a bond?

Whoever issues bonds can use them for the purpose of borrowing money from the financial market. Those who buy the bonds are remunerated by interest and will receive the term provided upon issue of their reimbursement.

We're done, we hope reading this article has opened your eyes to all the gray areas regarding bonds. If this is the case, please provide your comments so that we can see how we can improve to best satisfy you in the future.

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