Bonds refer to debt instruments which are issued by municipalities, governments and companies for raising funds in order to finance their capital expenditure. Bond purchasing by an investor means that he loans an amount of money for a definite time period on a predetermined interest rate. The bond holder gets paid for the interest at certain intervals, while the principal amount is paid back to him later on at the maturity date. Bonds and stocks are both securities, but bondholders are regarded as lenders while stockholders are basically the owners of the company.
Bonds – major types
The main forms of bond include:
• Government bonds: These refer to debt securities with fixed income that a government issues. Government bonds are again classified based on the maturity term or duration.
a. Government Bills: These are a kind of government bonds with a maturity term of less than twelve months.
b. Government Notes: These are a type of government bonds having a maturity period extending from one year to ten years.
c. Government bonds: These are kinds of debt securities which mature in greater than ten years.
The U.S government’s marketable securities are collectively known as Treasuries. Treasuries issue Treasury bonds, Treasury notes and Treasury bills or T – bills.
• Municipal bonds: Debt securities which are issued by local/state governments and their agencies are called municipal bonds. A major advantage with this type of bond is that the interest has been exempt from local tax or federal income tax. Because this form of bond amounts to tax savings, the yield is lower as compared to a taxable bond.
• Corporate bonds: Companies issue debt instruments backed by their capacities for generating profits or by their present physical assets value. A short-term corporate bond has a less than five years period, intermediate corporate bond is five to twelve years and a long-term corporate bond has a more than twelve years period. Corporate bonds generally give higher yields than government bonds because companies have a greater risk of defaulting in comparison to a government. Some forms of corporate bonds are:
a. Convertible bonds: The holder of these bonds can convert that into stock.
b. Callable bonds: These forms of bonds permit the organization for redeeming an issue before maturity.
Bond dealers usually are responsible for bond trading. Bond trading can happen almost anywhere where the buyer and the seller decide to strike the deal. Quite unlike equities, bond trading has no exchange listings, and is mostly carried out through an “over-the-counter” market. Certain exceptions include a few corporate bonds, especially in the United States which are listed on an exchange.
You must ensure correct estimation of the bond’s price when you wish to trade it with some other investor. The main factors to consider are the interest rates prevailing in the market, and inflation. Higher the interest rates, new bonds turn more lucrative with people making a beeline for those rather than the existing bonds. High inflation also eats away the value of the bond after maturity.