Bonds

What are Bonds

Bonds are fixed income instruments that represent a loan made by an investor to a borrower (typically corporate or governmental). Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer.

How Bonds Work
When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing debts, they may issue bonds directly to investors. The borrower (issuer) issues a bond that includes the terms of the loan, interest payments that will be made, and the time at which the loaned funds (bond principal) must be paid back (maturity date). The interest payment (the coupon) is part of the return that bondholders earn for loaning their funds to the issuer. The interest rate that determines the payment is called the coupon rate.
Are Bonds a Good Investment?
Bonds tend to be less volatile than stocks, and are typically recommended to make up at least some portion of a diversified portfolio. Because bond prices vary inversely with interest rates, they tend to rise in value when rates are falling. If bonds are held to maturity, they will return the entire amount of principal at the end, along with the interest payments made along the way. Because of this, bonds are often good for investors who are seeking income and who want to preserve capital. In general, experts advise that as individuals get older or approach retirement, they should shift their portfolio weights more towards bonds.
Types of Bonds

  • Government Bonds – These are bonds issued by a national government, denominated in the country’s own currency, for example Australia Commonwealth Government Bonds and US Treasuries. Government bonds are usually referred to as risk-free bonds with very low default risk and are among the safest investments, because the government can raise taxes or print money to redeem the bond at maturity. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.
  • Corporate Bonds – These are bonds issued by companies to raise money for business purposes, e.g. to expand operations or fund new business ventures. Corporate bonds usually pay higher rates than government bonds, because they tend to be riskier. Corporate bonds have a wide range of ratings, reflecting the fact that the financial health of issuers can vary significantly. (Please refer to the rating agency section). High yield bonds are issued by lower quality corporates and therefore have higher yields to compensate for the additional default risk.

How you make money from Bonds
There are two ways to make money by investing in bonds. The first is to hold those bonds until their maturity date and collect interest payments on them. Bond interest is usually paid twice a year. The second way to profit from bonds is to sell them at a price that's higher than you initially paid. For example, if you buy $10,000 worth of bonds at face value -- meaning you paid $10,000 -- and then sell them for $11,000 when their market value increases, you can pocket the $1,000 difference. Bond prices can rise for two main reasons. If the borrower's credit risk profile improves so that they’re more likely to be able to repay the bond at maturity, then the price of the bond typically rises. Also, if prevailing interest rates on newly issued bonds go down, then the value of an existing bond at a higher rate goes up.
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