What are Bonds?

 What are Bonds?

Bonds are a classic among securities and belong in every custody account. An investment in bonds is also very interesting for our protagonists Anna and Michael. In this video you will learn, together with the two of them, which special characteristics bonds possess and what you should pay attention to when investing. 

Large offer, fixed interest rates, repayment at maturity

The bond market is booming: If we combine the financial markets of Europe and North America, January 2017 saw more bonds issued than ever before in a month. Many of these bonds are also traded on the stock markets. 

But let's go back to the beginning. To let you know what is meant when we talk about bonds, here is an explanation: bonds are fixed-income securities. They are also called annuities, bonds, debt securities or bonds. Issued - the foreign word for this is issued - they are issued by credit institutions, states, municipalities or companies, for example. They serve those who issue bonds, the issuers, for the long-term procurement of capital. 

When you buy a bond, you lend the provider money, which you get back at the end and for which you get an interest rate, so the rule. Bonds are a kind of credit and you as the holder of the bond creditor. The right to repayment, the amount and frequency of the interest rate as well as the maturity are securitized among other features in the terms of issue. 

Black on white: the main features of a bond

Nominal value: The nominal value is the amount of money noted on the bond. It indicates the amount of the monetary claim and forms the basis of interest. Another word for it is nominal.

Interest rate: Interest on a bond is usually expressed in percent and can be paid annually, semi-annually, quarterly or even monthly. Annual interest payments are common in Germany. The level of interest depends on the solvency of an issuer, its creditworthiness. The worse the credit rating, the higher the risk that the bond will not be repaid. Accordingly, the buyers of a bond expect a higher return on their invested capital. 

Maturity: This is the period during which the capital is tied up in the bond. At the end of the term, issuers usually pay back bonds at their nominal value. During the term, they can also be sold on the stock exchange, but at the then valid price, which usually deviates from the nominal value. It can be higher or lower. 

Redemption: Bonds are usually redeemed at the end of their term, i.e. repaid. A distinction is made between bonds with bullet repayment and those with instalment or annuity repayments. 

The most common type of repayment is bullet repayment. This means that the issuer repay the total amount of the bond it has issued at maturity. Installment and annuity bonds are redeemed during their term. If issuers experience payment difficulties or fail completely, bonds are not repaid. 

Issue price: Bonds may be issued at face value (at par), below face value (below par) or above face value (above par). Bonds are more frequently issued below par, i.e. below 100 percent of the nominal amount, but are redeemed 100 percent at maturity. As a result, part of the capital invested is not subject to interest until the maturity date. 

Percentage quotation: Most bonds are traded on the stock exchange. Unlike shares, for which investors pay a euro amount per share, bond prices are expressed in percent and can be above or below the nominal value.

Investors therefore pay the percentage price in euros for a certain nominal amount. If a bond is quoted at 105 percent, an investment of 1,000 euros nominally pays 1,050 euros in real terms. As with shares, the bond price is determined by supply and demand. 

Accrued interest: If bonds are bought or sold during the term, the buyers pay accrued interest to the sellers in addition to the real purchase amount. Since the previous interest date, interest payments have accrued, which will be paid to the new bond holders on the next interest date and the accrued interest will be paid back to the old holders. The published bond prices are usually without accrued interest, so that these are added to the invested money. 

Minimum investment and denomination: Most bonds have a minimum investment amount, often 1,000 or 100,000 euros nominal. In addition, they can only be bought in certain nominal value increments, the denomination. Shares, by the way, are traded from one unit upwards. 

How safe are bonds?

Unlike a share, as the holder of a bond you have no ownership or shareholder rights in the issuer of the bond. Investors only have a right of indebtedness to the issuer to whom they transfer their money. Bonds are therefore associated with the risk that the issuers will not be able to pay the interest or, in extreme cases, will not be able to repay the bond at all.

Investors must decide whether they trust issuers to be able to repay the bond at maturity. Here is a historical example: In the US Civil War (1861-1865), the southern states had issued a bond to finance the war. The war was over, the southern states defeated and insolvent. The result: the bond was not repaid, the investors lost their money.

Nevertheless, bonds are considered less risky than equities because of their securitised interest rate. Therefore, the average yields of equities, i.e. dividends and price gains, are higher than the bond yields - price gains and interest rates - of comparable issuers with corresponding risk. 

Criteria for bonds: debt level, new indebtedness, economic stability

The security of the investment, especially the creditworthiness of the issuers, should be in the foreground when you want to buy bonds. But how can you tell how safe a bond is?

If, for example, you want to invest in government bonds, the following criteria are crucial for assessing creditworthiness: the level of debt compared to gross domestic product (GDP), net new debt, economic growth and political stability. 

For example, a debt of more than 60 percent of GDP is considered comparatively high and also exceeds the criteria set by the Maastricht Treaty for members of the euro zone. For many investors, the trend towards new debt is therefore more important than absolute debt. For emerging markets, on the other hand, it depends on how stable their political conditions are. 

If you want to subscribe to corporate bonds, it depends on whether the company in question can master difficult economic times.

Here you will find information on the creditworthiness of countries and companies.

They do not have to laboriously search for the creditworthiness of states and companies themselves. Professional rating agencies assess the creditworthiness of debtors and summarise their assessment in grades of triple A ("AAA"), C to "D". You can find these ratings on financial portals on the Internet and on the websites of the individual agencies. Boerse-frankfurt.de offers a matrix with a classification of the various credit ratings. 

Post a Comment