Meaning of Bonds

Meaning of Bonds

Bonds is the English name for fixed-income securities, or bonds for short. This type of security certifies the right to a recurring interest payment within a predetermined period of time. At the end of this period, the investor will be repaid the nominal value stated in the certificate.

  • Bonds are used to borrow funds on the capital market and are used by the public sector and companies alike. Corporate bonds are referred to as “corporate bonds”.
  • Traditionally, bonds consist of two sheets. Sheet one, the cover sheet, certifies the right to interest payment, states the term of the bond and the investment amount brought in with the respective certificate.
  • Sheet two, the sheet, contains the coupons. One coupon is redeemed for each interest payment. The coupon shows the due date and the amount of the interest payment.

Legal position of the bond

In contrast to a share, a bond does not serve to increase equity, but only means borrowing with later repayment. In addition to classic bonds with regular interest payments, the following other stocks fall into this asset class:

  • Convertible bond: Can be exchanged for shares in the issuing company within a certain period of time.
  • Warrant bond: bearer bond with the additional right to purchase shares in the company.
  • Indexed bond: In addition to the fixed interest rate, it also contains a variable interest rate component that depends on the development of the underlying index.
  • Floater: bond whose interest rate is variable linked to the development of another interest rate, for example the interbank rate LIBOR.
  • Income bonds: In addition to guaranteed interest, they also offer entitlement to a share in the company’s profits.
  • Zero coupon bonds (zero bonds): The agreed interest rate is deducted upon purchase, the payment is made at the nominal value. If the zero bond runs for one year, the interest rate is one percent and the issue takes place without a front-end load. However, if the investor pays 99 euros for a paper with a nominal value of 100 euros, he will receive 100 euros upon maturity.

Bonds are issued with a certain nominal value, for example 1,000 euros or a multiple thereof, but the price is quoted in percent. It is entirely permissible for the issuer to place the bond on the market at a percentage higher than 100 percent. Bonds from debtors with first-class credit ratings generate additional income in this way. From the time of issue, bonds are traded on the stock exchange. The future course results from supply and demand. The repayment is made at the nominal amount, even if the issue price was above 100 percent.

Domestic and foreign issues

A bond does not necessarily have to be placed on the market in the home country of the issuer. Yankee bonds, for example, are issues of bonds on the US market in US dollars by a company based outside the US. The Japanese market understands samurai bonds to be issued by foreign issuers if the bond is issued in yen. In the case of Uridashi bonds, the bond issued by a foreign issuer in Japan is understood to be in a currency other than the yen.

Calculating the return on bonds

Bonds usually have a fixed interest rate. However, the return does not have to be identical to the nominal interest rate. Depending on whether the acquisition takes place at a price that is above or below the nominal amount, the return also changes. If an investor buys a short-term one with a duration of one year at a price of 100.5 percent on the day of issue and is entitled to an interest payment of 1.5 percent, the return is 1.5 percent interest less an issue surcharge of 0.5 Percent only one percent over the year.

The maturities of bonds

The term of a bond can be up to 30 years. Bunds have maturities of 10, 12, 15 and 30 years. US Treasury Bonds (American government bonds) also have a term of between 10 and 30 years.

Advantages of bonds

In contrast to stocks, bonds are subject to lower price fluctuations. The interest rate depends on the creditworthiness of the issuer. Investors who are more willing to take risks acquire paper from weaker issuers and thus increase the return. Conservative investors fall back on bonds from issuers with the best credit ratings and can thus be sure that they are holding a return in line with the market with the best security in their portfolio.