What is an Investment Bond?
A bond is essentially a loan contract between two parties. The seller of the bond receives a loan from the buyer of the bond, for the value stated on the bond. The bond issuer (seller) then pays the bondholder (buyer) the interest due on that loan (bond), periodically for the entire duration of the bond. Upon maturation (or expiry) of the bond, the bond issuer will pay back to the bondholder the entirety of the original capital that was lent via the bond (aka the face value).
This makes bonds units of debt issued by an entity, usually a corporation or government, and this debt is non-collateralized. Thus, depending on the bond issuer, this can be a relatively safe or relatively risky investment, with interest (coupon) rates on these bonds compensating for such increased or decreased risk. Bonds are categorized as fixed income securities, as the interest generated periodically will be fixed, though variable rate bonds are also available.
Why Bonds Are Issued?
Companies and governments will issue bonds to raise capital through debt to fund business expansion or expenses. In the case of a business, it may be expansion of reach or capacity, while governments will borrow to fund development and wars. This volume of borrowing is usually significantly more than any bank is able to meet and thus bonds, through public debt markets, provide an excellent route to raise the funds needed.
Bonds Are Thus Tradeable
Once issued and sold to the public or investors, bonds then become tradeable as securities on centralized exchanges or in OTC markets. The price of a bond will be affected by applicable interest rates, with interest rates having an inverse relationship with the price of a bond; i.e., when rates rise, prices fall and vice-versa. Bond prices are also impacted by forces of supply and demand in the market, credit quality of the issuer, time to expiration and coupon rates vs. interest rates.
Here are some important terms you come across when dealing with bonds:
Face Value – This is how much the bond will be worth at maturity and it is also the reference amount used to calculate interest payments. Basically, it is the amount that was originally borrowed via the bond, regardless of the current price of the bond. For example, in the case of a bond with a face value of USD 1,000; whether you buy it at 1,050 or 950, you will still receive only 1,000 at maturity.
Coupon Rate – This is the interest rate the issuer will pay on the bond.
Coupon Date – This is the date(s) on which interest payments are made.
Maturity Date – The date on which the bond will mature.Issuing Price – Original price the issuer sold the bonds for.