What Are Bonds?
Bonds have always been considered a reliable investment instrument. When a person issues a bond, they create a liability, so bonds become a form of tradeable debt. You can say that the issuer owes a creditor (i.e., you) a debt they are obliged to repay, just like with any other ordinary loan. So, think of it as an I.O.U. between the lender and the borrower. A bond is a security that can be issued to finance virtually any operation. Governments commonly use bonds to raise funds; they are the principal issuer of bonds. National bonds are one of the most common examples of national debt because when you purchase a government bond, you basically lend them your money. Not only do government bonds support government spending and finance budget deficits, but they also determine the profit municipalities and corporations would get from their bonds.
If you are a fan of a conservative investment strategy, bonds are your go-to. Bonds are fixed-income securities: the issuer sets out a fixed rate of interest, so creditors receive a set level of interest cash flows they know in advance. That said, income is sensitive to supply and demand and can change when issued. Generally, any nominal yield you receive from a bond is called a coupon rate. There are fixed-income coupon rates we discussed above, and then there are your variable pay coupon rates, which means they are tied to inflation or international market interest rates.
Types of Bonds
You have a choice of internal bonds denominated in domestic currency and featured on the local national market, and international, or global, bonds, usually denominated in popular foreign currency, like the dollar or euro. With that in mind, you need to remember that they are regulated and circulated differently.
Unlike shares or stocks, bonds do not represent a stake in a company. The issue of new bonds does not affect ownership or company operations. They are simply an I.O.U., so if you’re looking to obtain equity in a company, you are going to have to go a different way. There are, of course, exceptions: convertible bonds, i.e., bonds that can be exchanged for a specified number of common shares. They are a rarity on financial markets, though.
Bonds can be classified by:
- - issuer;
- - maturity;
- - type of yield;
- - currency;
- - being (non)convertible;
- - reason for issue;
- - investment appeal;
- - rating (credit quality).
Bonds as a Tool for Conservative Investors
Bonds are more stable and safer than shares. If a company goes bankrupt, bondholders are more likely to recover their losses as the company has promised to pay interest and return principal. They have the comfort of knowing that they are second in line for payment, unlike shareholders who may have to say goodbye to everything they invested in. Government bonds are the best for those looking for safety and a reliable cash flow. They are a safe and good option when it comes to protecting money you invest. But there’s always a fly in the ointment; government bonds are low-yield, which means investors are very uncertain about their economic future in troubling times.
Despite everything, investors do not seem to be giving up on bonds. There are a few reasons why. First, bonds are better than anything at protecting and preserving your capital. Second, they can be used as collateral for other trading positions.
Pension funds and large conservative investors are the main buyers of long-term investment bonds because they are interested in low-risk investments that provide a steady cash flow. Sometimes, a country’s Central Bank will purchase securities to increase the money supply as part of its quantitative easing policy. This encourages lending and investment and reduces interest rates, stimulating economic activity during hard times. You can say that it is an extremely liquid market.
Bond Trading: Location, Location
You can usually find bonds denominated in domestic currency on the stock exchange. Central Banks or financial ministries sometimes sell government bonds through auctions guaranteeing access to a wide group of investors. Large financial institutions, such as banks, usually handle the issuance of Eurobonds by subscription.
However, you cannot go wrong with an exchange: it is the primary source of bonds, so when in doubt, go there.
Why Choose Bond CFDs?
Once issued, bonds are traded on authorised exchanges, and any willing investor can execute a trade and buy them. But it is not just enough to be willing. You have to be rich, too. Or at least rich enough to invest in bonds because they are not a cheap instrument and come at a price (a price of considerable equity). So, if you can’t or won’t spare a small fortune on bonds, you can easily trade bond derivative financial instruments, for example, CFDs. CFDs mean you can fractionalise and trade accordingly. CFDs mean greater investment portfolio protection. CFDs mean you do not have to spend as much money on your investment.
Why Not Choose Bond CFDs?
A CFD broker does not pay out any coupon yield (if set out in the bond prospectus) to an investor. This is a far cry from the stock market. So bond CFDs only provide protection. Of course, they can return some yield if the exchange rate changes, but that is usually it.
Bonds are extremely reliable, low-risk instruments, even if you have to settle for lower returns. A country rarely defaults on its debts, unless it’s a particular Latin American country. Not to worry, though. Even bankruptcy saves an investor holding bonds at least part of their original investment; debt restructuring might even turn out to be profitable for bondholders down the road. That said, bonds are a low-yield instrument, hence with almost non-existent risks. Obviously, if you choose a riskier instrument, it will be more satisfying if you play your cards right because with bonds, the yield does not even cover inflation at times. What does that mean for an investor? A loss.