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Bonds

What Are Bonds?

 

Bonds are debt financial instruments.

 

Simply put: when you buy a bond, you lend money to a party (government, company, public body), which undertakes to repay the amount invested (principal) at a future date (maturity), paying regular interest (coupons) in the meantime.

 

They are considered less risky than stocks, because:

  • They give you predictable income (coupons)

  • Repayment of capital is virtually guaranteed (barring bankruptcy of the issuer)

What Are the Different Types of Bonds?

 

The most common types of bonds are:

 

  • Government Bonds: These are issued by governments. They generally have low risk and modest returns.

  • Corporate Bonds: These are issued by companies. They generally have higher yields, but are riskier.

  • Zero-Coupon Bonds: They do not pay any coupon. They are bought at a discount and the principal is collected at maturity.

  • Indexed Bonds: They pay coupons linked to inflation or a variable rate.

  • Convertible Bonds: Can be transformed ("converted") into shares of the company.

  • Perpetual Bonds: They have no fixed maturity. They pay coupons indefinitely.

 

Bonds Key Characteristics

 

Predictable performance

  • You know how much you get and when (coupons).

 

Deadline defined

  • It can range from a few months to decades.

 

Variable market price

  • Bonds are bought and sold after they are issued and before they mature, and their value fluctuates.

 

Credit Rating

  • Each bond has a rating on the strength of the issuer (e.g. AAA = highest credit rating, CCC = high risk).

 

Liquidity

  • Some are widely traded (e.g. government bonds), others less so.

Benefits of Bond Investing

 

  • Fixed Income: Useful for planning regular income

 

  • Generally lower risk than stocks

 

  • Diversification: Reduce portfolio volatility (risk)

 

  • Capital protection (especially with government bonds)

 

  • Useful in unstable market scenarios

Main Risks

 

Interest rate risk

  • If rates rise, the price of bonds falls (and vice versa) if they are sold before their maturity.

 

Credit risk

  • If the issuer is in difficulty, it may not pay the coupons or the principal.

 

Liquidity risk

  • Not all bonds are easy to resell before maturity.

 

Inflation risk

  • If inflation rises a lot, the real value of the coupons falls.

 

Exchange rate risk (if in foreign currency)

  • If you invest in bonds denominated in USD, JPY or other, you are exposed to the exchange rate.

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