What is a Bond?
When company issues bonds, it simply raises funds through borrowing money form investors. It works straightforward:
- You buy bonds for their face value (most often 1000$);
- You receive coupon payments (fixed interest rate) periodically (annually, semiannually or quarterly);
- You receive a face value of the bond at maturity (from 7 days to 30 years).
Of course everything is not as simple as it seems to be. There are bonds which do not provide coupon payment and are simply traded at discount; bonds also can be convertible (giving bondholders an opportunity to exchange each bond for a specified number of shares of the company); even coupon payments can be different depending on some measure of current market rates or inflation (if bond is with a floating-rate).
Before the 2006 World Cup FIFA issued “Catastrophe Bonds”. The idea is that payments would be stopped in case of cancellation of World Cup because of terrorism. These bonds are an opportunity to transfer risk of catastrophe form the company to the capital markets.
Credit rating of company.
Before you buy a bond, you need to get an idea of trustworthiness of the issuer. Three of the most popular rating services (Moody’s, Standard & Poor’s, and Fitch) provide Bond Credit Quality Ratings which can tell you what is a probability of default of the company and how reliable it is.
US Treasury Bonds.
U.S Treasury Notes are considered to be “Risk-free” debt instruments. Because it is assumed that your investment is absolutely safe, Treasury bonds tend to pay lower interest rate than other comparable bonds.
Why to invest in bonds?
- The most important advantage is that bonds are way less risky than shares.
- Bonds are often liquid: it is often fairly easy for an institution to sell a large quantity of bonds without affecting the price much.
- There are also a variety of bonds to fit different needs of investors.
However, there are some drawbacks:
- Even if bonds are less risky than shares, risk still exists: bondholders may lose much or all their money if the company goes bankrupt.
- Your potential gain is limited.
- Fixed rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise.
Investing in shares/equities or other financial instruments are considered as high risk. Above mentioned is not a recommendation to invest in those securities nor is it given any sort of advice or can be considered as complete information. Please seek for an expert advice.