2) BONDS đź”—
Bonds represent a loan made by an investor to a corporation.Â
Investors would be paid an annual interest based on a fixed percentage of the original amount of money used to buy bonds, earning the interest for a certain amount of time. After a certain amount of time, the company will pay back the full bond value to investors
E.g. If Mr Lee buys $5000 worth of bonds, and is promised to receive 5% per annum for 4 years, he will receive $250 per year, earning $1000 in interest profits. After 4 years, the company will pay him back $5000
Why/Why not use bonds?
AdvantagesÂ
Less Risky and Volatile, with fixed deposits and interest rates, sort of like an income
Income storage: Money is stored with the company, who is liable to pay you back the full amount after the bond's time runs up
If the price of bonds increases, you can sell them for a profit
DisadvantagesÂ
Little potential for bigger profits and returns, with interest rates fixed at purchase
Companies can default on bonds if they bankrupt, though you have a high claim to their liquidated assets
What determines the price of Bonds?
Bondholders can sell bonds in the open market.Â
This flexibility leads to fluctuations in bond prices based on supply and demand.
Interest Rates: Bond prices are sensitive to changes in prevailing interest rates. As interest rates shift, bond prices move to find equilibrium, either rising when rates drop or falling when rates rise.
When interest rates in the economy rise, the attractiveness of existing bonds with lower interest rates diminishes. Investors might prefer newer bonds offering higher interest rates, causing the prices of older bonds to decrease.
Conversely, when interest rates decline, previously issued bonds with higher coupon rates become more appealing. Their fixed-interest payments become comparatively attractive, driving up their prices
Who issues bonds?
Bonds can be issued by many organizations. Primarily, governments and corporations issue bonds, using the capital raised to fund projects like new infrastructure, research, and more.
Municipal/Government Bonds
Bonds issued by governments or states, like the Singapore Government Securities (SGS) Bonds in Singapore.Â
Corporate Bonds
Bonds issued by aorporations and companies, like Apple or ExxonMobi
Special Types of Bonds:Â
Zero-Coupon Bonds (Z-Bonds):Â
Issued at a discount to their par value and do not pay regular interest (coupon) payments. Instead, bondholders receive the full face value when the bond matures.Â
E.g. U.S. Treasury bills are examples of zero-coupon bonds.
Convertible Bonds:Â
Allow bondholders to convert their debt into company stock based on specified conditions
Benefits both the company and investors.Â
Companies may issue these bonds to lower interest payments, and investors accept lower coupon payments for the potential to benefit from rising stock prices.
Callable Bonds:Â
Callable bonds give companies the option to "call back" the bond before maturity.Â
If interest rates decline, companies may recall the bonds and issue new ones at a lower rate.
Riskier for bondholders, as their bonds can be called back at any time
Puttable Bonds:Â
Allow bondholders to sell the bond back to the company before maturity, protecting them from potential price declines or rising interest rates.Â
References
Jason Fernando, "Bond: Financial Meaning With Examples and How They Are Priced", Investopedia, last modified March 2023, https://www.investopedia.com/terms/b/bond.asp