What Are Bonds? How Bonds Work?
If you want to invest and diversify in the stock market, you could find the right investment in bonds. Bonds are simple instruments for banks, institutions, governments, and companies to raise money. Investors receive interest in return and can also benefit from rising prices. In a portfolio of equities, bonds, either as a major component or as a minor component, can limit volatility and reduce risk.
What are bonds & bonds and how do they work?
Bonds are fixed-income securities that can be traded on the stock exchange and certify the right to receive money back after a term has expired and to receive interest in the meantime. The terms “bonds”, “bonds” and “ debentures ” are also widely used for bonds.
Put simply, behind every bond is a loan that investors grant to the issuer of the bond. The issuer promises the purchaser of the bond regular interest payments ( coupon ) over the entire term. Repayment is made at the nominal value at the end of the term.
Essential features of bonds are fixed interest rates and a fixed term. Find the best fixed rate bonds here. Bond issuers can be banks, institutions, companies, and states. Investors can come from private or institutional sources. Bonds are always assessed according to their creditworthiness and assigned to various categories (e.g. “investment grade”, “speculative” or “junk”). That is the job of rating agencies. The rating ranges from AAA as the best rating to D (default).
What types of bonds are there?
Simply explained, bonds are differentiated according to the type of interest, type of issuer, or other specific characteristics such as their structure. Depending on the type of interest, the bonds are divided into classic bonds, zero coupon bonds, and bonds with interest coupons. Based on the issuing issuer, a distinction can be made between government bonds and corporate bonds.
In addition, there are many different sub-types of corporate bonds that are very similar in general and usually only differ from one another in certain detail. Pfandbriefe from banks and federal securities also belong to this category.
Another type of classification is based on specific characteristics. A distinction can be made between foreign currency bonds and participation certificates, for example. Subordinated bonds, bonds with warrants and convertible bonds as well as structured bonds are also subtypes.
Read also: The Process of Investing in a Loan Business
Can you sell a bond before the end of the term?
Yes, investors can sell bonds before the end of the term and thus secure the opportunity for price returns. Bond prices work similarly to stocks, active funds, or ETFs. The difference is that the price of a bond is not measured in euros but as a percentage of the face value.
The price of a bond is subject to constant fluctuations on the stock exchange – which has to do in particular with the creditworthiness of the company, the bank, or the state as well as with the trading activities on the stock exchange according to supply and demand. At the end of the term, the price always approaches 100% again. At the end of the day, bondholders get exactly the amount they invested back. They have already received the interest by the time they are not reinvested.
