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) desires 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 friend called the State. He needs money to build roads, schools, all that. So he says to you: “Lend me 1000 balls, and I will return them to you in 10 years with interest.” That's a state obligation. It's considered super safe, because hey, the State isn't going to make off with your money, is it? On the other hand, as it is certain, it does not bring in thousands and cents either.

It's a bit of a cushy investment for people who don't want to take the hassle. There are short-term, medium-term, long-term obligations… 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 how the wind turns, you can win or lose. It's a bit like a poker game with the global economy.

Corporate bonds

There, it's as if a big company, like Apple or Total, was telling you: “Hey, we have a great project, but we need cash. Will you lend us?” It works like government bonds, except that it's a company that borrows. It's generally considered a little riskier than government bonds, because hey, a company can always go bankrupt. But as a result, it often pays a little more. There are different qualities of corporate bonds.

The best are what we call “investment grade“. It's a bit like if you had a grade at school: if you're above average, you're good. Below, we enter 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 being eaten up by inflation. You know, when everything goes up and your 20 euro bill is worth more than shit? Well, these obligations 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. This is particularly interesting when inflation starts to act 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 gone down the drain, but when it goes south, you're very happy to have it.

Convertible bonds

So that’s the Swiss army knife of bonds. You have the advantages of a classic 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 if you lent money to a friend who was launching his start-up, and he said to you: “If it works, you can become a shareholder if you want.” Pretty cool, right?

If the box is a success, you can potentially make a nice profit. On the other hand, if things go wrong, well, you still have your obligation. It's kind of the best of both worlds. But be careful, it's not the goose that lays the golden eggs either. It generally pays less than a traditional bond initially, because you have this conversion option. It's a bit like paying for insurance so you can benefit from the success of the business.

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 do not necessarily have a great financial reputation. As a result, to attract investors, they offer higher interest rates. It's tempting, huh? But be careful, there is no miracle: more return = more risk.

It's like lending money to your friend who always has brilliant ideas but always ends up screwing up. He promises to reimburse you double, but you're not sure you'll see your money again. These bonds can pay off big, but they can also leave you stranded if the company goes bankrupt. It's a bit of a roller coaster of investing.

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

OK, let's talk about the benefits of bonds. I'll explain them to you as if we were chatting over a beer, is that okay with you?

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 to yourself “Damn, I lost everything!”. Of course, there's always a risk, but compared to stocks that yo-yo, it's pretty easy. It is the choice of people who prefer to sleep peacefully rather than dream of a yacht.

Regular income, such as a salary

With obligations, it's a bit like having a second job, except you have nothing to do. You receive interest regularly, often every six months. It's great to make ends meet or to pay for that little extra you want. Some retirees love it to have a stable income in addition to their pension. It's like having a small part-time job, but without the boring boss and the crappy hours.

You know where you're going

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

The risks of buying a bond

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

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

Imagine that you lend your friend some money. He swears to you that he will repay you, but on the big day, poof, he disappeared into thin air. Well with bonds, it's the same. If the issuer (the state or the company) goes bankrupt, you're in trouble. Your beautiful tickets, you can say goodbye to them. It's rare for states (although it does happen), but for businesses, 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 nasty thing. You buy a 3% bond over 10 years, quite happy. Except that two years later, the rates rose to 5%. And there, you seem smart with your bond which brings in nothing but peanuts. If you want to sell it before maturity, you will have to lower the price so that someone will be willing to buy it from you. It's like you bought the latest iPhone just before the new model came out. Suddenly yours isn't worth much anymore.

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

Inflation is the bane of savers. If your bond earns you 2% per year, but inflation is at 3%, in reality, you are losing purchasing power. It's like you're running on a treadmill that's going faster than you. You're making an effort, but you're not moving forward. Unless you took 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 find yourself stuck with your obligation, unless you sell it. This especially happens for little-known bonds or when the market is choppy.

Currency risk, for adventurers

If you buy a bond in a foreign currency, you have 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 the same time: bonds and currencies. There you go, buddy. It's not to freak you out, right. But as they say, forewarned is forearmed. Or a savvy woman, 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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