What are bonds? Getting to know its types and terms
Many of us cannot afford to buy things like a car, a house, or further education without taking a loan. Just as people borrow money to get something, so do businesses. Businesses usually need loans to finance their activities, presence in a new market, innovation, and growth. But their required amount is often higher than the bank’s capacity. So another method for companies is to finance by issuing bonds to people who want to buy them. Consequently, a bond is a loan. Read the article below to see exactly what bonds are.
When you buy a bond, you are actually lending money to the company that issued the bond. In return, the company pays you interest during the loan period. The amount and period of interest payment depend on the terms of the bond. Interest rates are usually higher in long-term bonds. Interest payments are usually made semi-annually; But there are also annual, quarterly, or even monthly payments. When the bond matures, the issuer repays the principal.
For you as a lender, bonds are a type of investment just like stocks. But the difference is that shares are not loans. Shares mean ownership in a company, its yield depends on the profit of that company. Because of this, stocks are riskier and more volatile and fully reflect the success of a company. On the other hand, bonds often have fixed interest rates. Some bonds have a floating rate in the sense that their interest rate is adjusted depending on market conditions.
Bonds can be traded like stocks. When a person sells his bonds at a price lower than the nominal value of the stock ( face value ), it is said that the sale was made at a discount. But if it is sold at a price higher than the nominal value, it is said that it has been sold at a premium. Where Is The Serial Number On A Savings Bond?
Types of bonds
- Government Bonds: Governments issue bonds to finance programs, pay payroll, and especially pay bills. Bonds of stable countries like America are considered among the safest investments. But on the other hand, bonds of developing countries have a higher risk. The US government issues its bonds through the Treasury and several different government agencies. In America, bonds with a maturity of less than one year are called T-bills, bonds with a maturity between 1 and 10 years are called T-notes, and those with a maturity of more than 10 years are called treasury bonds. In some cases, the interest received from these bonds does not include income tax.
- Municipal bonds: These bonds are issued by various states, cities, countries and regions to finance operations or pay for projects. Municipal bonds finance the construction costs of hospitals, schools, power plants, streets, administrative offices, airports, bridges, etc. Municipalities usually issue bonds when they need more money than the money from tax collection. One of the advantages of municipal bonds is that the profit is tax-free.
- Corporate Bonds: Corporate bonds are issued by businesses to help finance them. Although the risk of these bonds is higher than government bonds, but more money can be earned from them. There are also more options to choose from among corporate bonds. But one of the disadvantages of these bonds is that they are not exempt from taxes.
Especially regarding investing in corporate bonds, it is very important to consider bond risk. No investor likes to spend his money on a low-yielding bond with a 50-50 chance of bankruptcy. To buy corporate bonds, one should research the issuer’s financial situation and economic outlook. These investigations can include the amount of cash flow, debt, liquidity, and the company’s business plan.
While it may be fun to do such research, most of us don’t have the time or skill to properly analyze a company’s financials. Fortunately, companies such as Moody’s Investment Services and Standard and Poor’s do this. Their experts examine the status of companies and determine their rank.
The rating service of each of these companies has its own formula for measuring risk and scaling ratings. Ratings are usually scaled alphabetically, ie AAA rating is assigned to safe and low-risk bonds, and the D rating is assigned to the riskiest bonds. Safe bonds, such as US government bonds, are usually low-yield bonds. This means that you can be sure of the return of interest and principal, but the amount of interest is low.
On the other side of this spectrum, there are bonds called Benjal bonds, which have a low credit rating and high risk. Companies issuing these bonds promise high returns to attract investors. If you buy Benjal bonds, there is no guarantee that you will get your money back. But if your money comes back, it will come with a very good interest.
Bond terminology
Bonds may have features that favor the seller or the buyer or both. Here are some terms that you should be familiar with before choosing a bond:
- Maturity: Bonds have a lifetime. Depending on the type of bond, this lifespan can last from 1 month to 50 years.
- Callability: This term means that the bond issuing company or agency can call the bond whenever it wants. In other words, the company redeems the bonds before the maturity date. A company may take this action when interest rates are falling, in which case it issues new bonds in order to retain more money. This is not always bad for the buyer; Because more interest is added to the bond principal.
- Put Provision: Like a call that the seller can redeem the bonds before the maturity date, some bonds have conditions that allow the buyer to sell the bonds to the seller before the maturity date with the same principal value of the bonds. . This cannot be done at any time, however, the seller should schedule it in advance. Sometimes those who own bonds sell them when interest rates are rising so they can invest their money where they can earn more.
- Convertible Bonds: Sometimes bonds can be converted into shares of the issuing company. When a convertible bond is issued, the exact time and price at which it can be converted into stock is specified. These types of bonds usually offer lower interest rates initially, but potentially more common stock.
- Secured Bonds: Bonds that are guaranteed by collateral are called secured bonds. This means that the company or agency issuing the bonds has enough money or assets to cover the value of the issued bonds. If the issuing company goes bankrupt, the money or assets of the company are given to the people buying the bonds.
- Unsecured Bonds: These bonds are not guaranteed by collateral. The only guarantee of these bonds is the credit of the company or agency issuing the bonds. Government bonds are unsecured; Because they have enough credit.
Bonds
Partnership bonds are a type of bond that is issued in Iran by the government, municipality, and public or private companies to finance construction, production, and service projects in the country. The Central Bank is responsible for the instructions and regulations for issuing these bonds. The only difference between partnership bonds and bonds is that the money received from the issuance of these bonds should only be used in specific construction, production or service projects; But in bonds, there is no specific limit for the issuer.
