Bond

A bond is an IOU, in simple terms. The issuer (borrower) undertakes to return the cost of the bond and pay interest (coupons) to the investor (lender) within the prescribed period. The investor knows in advance when the coupons will be paid.

What Are Bonds for and How to Buy Them?

The easiest way is to purchase bonds on the stock exchange. You can also buy or sell them privately or at over-the-counter auctions. It is most profitable to trade on the stock exchange.

The company borrows money on the stock exchange and determines the terms of coupon payment, the procedure for refunding funds, and the nominal value of the bonds. It is often easier and more profitable than borrowing from a bank. There’s no need for collateral or guarantees, unlike with bank loans.

If there is a non-payment of the principal and coupons/ delay, this is called default. In this case, you can regain money only if the financial situation of the company improves. Therefore, investors try to lend only to reliable companies.

Classification of Bonds

Basically, all bonds are divided into public and corporate ones.

Everything is quite clear with government bonds — they are issued by the state. They are considered quite reliable, however, their profitability is low. Corporate bonds are issued by various companies, and they are the most popular on the market.

Let’s take a closer look at corporate bonds by type:

• By method of placement: bonds are divided into public offerings and private placements.
• By type of collateral: bonds can be secured by any property or not.
• By interest rate type: this category includes fixed-rate and floating-rate bonds. If the company plans to increase production rates and increase profitability, it is better to choose fixed-rate bonds.
• By maturity term: this type of bond is divided into short-term (up to 1 year), medium-term (from 1 to 5 years), and long-term (more than 5 years).
• Callable bonds with options are particularly interesting. The investor has the right to demand early repayment of the bonds.

Investment Risks

1. Liquidity risk — many bonds are owned by large investors who plan to use them for a long time. The trading turnover of such securities on the stock exchange will not be high, and it can be extremely difficult to earn a significant amount on a large volume at the right price.
2. Issuer default risk calculation involves taking into account the probability that a particular company will not repay its debts. Such risks can be divided into two groups:

• Financial risks, related to a specific company. Risks increase if a company has a higher debt burden than its industry peers.
• Industry-specific risks. For example, the price of oil is falling, which means that the financial performance of oil and gas companies may fall, which in general will negatively affect their ability to repay their financial obligations on bonds.

3. Country risk — assessment of the risk that the state, considered as an issuer, may default on its obligations. There are also two groups in this category:

• Macroeconomic risks. For example, there’s the possibility that the new government may refuse to repay the financial obligations of the previous government.
• Political risks, including the state budget deficit, the amount of public debt in relation to the country’s GDP, etc.

Interesting Facts About Bonds

In 1997, the world-famous British rock musician David Bowie issued Bowie bonds. All payments on these bonds were secured by income from the future musician’s 25 albums. This set a trend, and many musicians followed suit by issuing similar bonds.