Bonds are debt instruments that act like an IOU in financial markets. The buyer of a bond is lending money to the bond's issuer. Usually, this is in return for a fixed stream of payments (coupons), which with the purchase price earns the buyer a rate of interest.
Issuing bonds is similar to taking out a loan, except the issuer is borrowing money from investors, not a bank. When governments wish to borrow money, they often do so by issuing bonds. Companies do this, too, for funding things such as investments or takeovers.
Most bond investors are banks (investing either for themselves or their customers), insurance companies and pension/investment funds. The average investor can invest in bonds, too, usually via a broker. Government bond original sales (or issuance) are through primary auctions. Most bonds can be sold through banks/brokers or, sometimes, secondary markets such as the New York Stock Exchange.
Most bonds involve two types of payments to the investor:
Note ⚠️
Repayment of principal and coupon payments aren’t the only way of making money from owning a bond. You could make capital gains if the bond’s price is higher at the time you sell it than when you bought it.
Bonds should be a consideration for anybody looking for a regular stream of income as part of a diversified portfolio.
There is no one-size-fits-all approach to bonds. You should assess whether you are suited for them in the context of the two investing objectives, risk and return.
Ask yourself whether you can bear the risk involved with the bond you are purchasing. Some bonds are riskier than others and depending on how big your overall investment portfolio is, individual bonds can make up an uncomfortably large proportion. As with any form of investment, your capital is at risk. Also, estimate what your returns will be - there is no guarantee they will be positive!
If a bond has a negative yield to maturity (YTM) then all the repayments (both the principal and all the coupons till maturity) will add up to less than what you paid for the bond.
Why would an investor buy a bond with a negative YTM?
Because they may feel that interest rates are going to decrease further in the future, and as we’ve already mentioned, most bonds are considered low risk, so investors who have to put their money somewhere, therefore, choose the safest bonds. Also, when interest rates go down, bond prices in the market will go up! In today’s economic climate, negative yield bonds are not a distant reality.
That said, most bonds fall under the low-risk category of the investment risk pyramid. This means that they are the type of investment that could be an important part of your overall investment portfolio.
WHAT ARE BONDS? COMPLETED. ✅
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