A bond is a debt instrument that is issued by the central/state government or PSUs, Corporate and other entities. There are three types of government bonds. These include:
T-Bills (matures within less than one-year)
TNotes- (mature in one to 10 years)
T Bonds- (matures within more than ten year)
A contract is made up of debt instruments. It refers to a loan agreement in which one party lends money to the other on pre-determined terms. These terms include the interest rate, payment period, and repayment of principal.
Stocks and bonds are securities. However, the main difference is that stockholders hold an equity stake in the company. They are the owners, whereas bondholders hold a creditor stake. They are lenders.
Another difference is that bonds have a fixed term or maturity. Stocks may remain outstanding indefinitely.
Underwriting is the most common method of issuing bonds. Underwriting is the process whereby one or more banks or securities firms buy the entire bond issue from the issuer and then resell it to investors.
Government bonds, on the other hand, are often issued at an auction. Sometimes, bonds may be offered for bid by both banks and members of the public.
The terms of the bond as well as the price paid will affect the overall rate of return. The coupon and terms of the bond are set in advance, while the price is determined by market forces.
As with all other assets, the forces of supply and demand determine the price of a bond. The price of a bond is also affected by a variety of factors. It can fluctuate depending on economic conditions, general market conditions including the state and supply of money in the economy, the prevailing interest rate, future expectations, and the credit quality of the issuers.
The issuer's face amount, or par, is the amount that the issuer pays in interest and must be repaid at term's end.
The issuer must repay the principal amount by the maturity date.
This is the interest rate the issuer charges bond holders. This rate is usually fixed for the entire term of the bond. You can also adjust it with a money index such as LIBOR.
It refers to the return earned from bond investing. Also known as borrowing cost, yield is also called Yield. It is usually refered to as:
Current Yield which simply refers to the annual interest payment multiplied by the current bond price. Or
Yield To Maturity This accounts for the current market price, as well as the amount of and timing of any remaining coupon payments along with the repayment due at maturity.
A yield curve is a graph that shows the relationship between yield and term-to-maturity. This graph shows the yield curve.
Inversely, yield and price are related. This means that when bond prices rise, bond yields rise and bond prices fall. The opposite is true for bond yield. When the market interest rate falls, it increases bond prices and decreases bond yield.
Fixed rate bonds come with a coupon that is constant for the entire life of the bond.
Floating Rate Bonds include a variable coupon linked to a reference interest rate, such as EURIOR or LIBOR.
Zero-coupon bonds pay no regular interest.These bonds are sold at a substantial discount to their par values so that interest can be effectively rolled up until maturity. The bondholder will receive the entire principal amount upon redemption.
High yield bonds are bonds rated lower than investment grade by credit rating agencies. These bonds are riskier than investment grade bonds and investors can expect to receive a higher yield.
Convertible Bonds allow a bondholder convert a bond into a number shares of the issuer’s common stock.
An arrangement in which the principal amount and interest payments are indexed according to inflation The interest rate on these bonds is usually lower than those with comparable maturities.
Investing In Bonds is mainly done by financial institutions such as banks, pension funds and insurance companies. Fixed amounts are payable at predetermined times by insurance companies and pension funds. They may be required by law to buy bonds in order to match their liabilities.
The portfolio's value will be affected by changes in the price of a bond. Falling bond prices can also affect the portfolio's value. This could be detrimental for professional investors, such as banks and insurance companies, pension funds, asset managers, and pension funds.
Fixed rate bonds are subjected to interest rate risk. This means that they will lose value if the generally prevailing interest rate rises. The market price of bonds will drop if the market interest rates rise. This is due to investors' ability get a higher rate elsewhere.
Bonds can also be subject to other risks, such as call, repayment, credit risk. These risks are only applicable to certain investors.