bonds

definition

Bonds are instruments of debt financing. The holder (creditor) receives regular interest (coupon) at an agreed-upon rate during the holding period and returns the principal at maturity. Key bond elements include par value, coupon rate, payment method, maturity date, and the issuer's credit rating. Bond prices fluctuate with market interest rates, credit risk, and supply and demand.

Way

Bonds can be categorized in a number of ways:

• By issuing entity: government bonds, local government bonds, financial bonds, corporate bonds, convertible bonds, etc.

• By interest form: fixed-rate bonds, floating-rate bonds, and zero-coupon bonds.

• By repayment method: one-time repayment of principal and interest, installment repayment, redeemable or puttable bonds.
  Investors can buy and sell bonds in the primary market (subscribe at the time of issuance) or the secondary market (exchange or over-the-counter).

Advantages

• Stable returns: Interest payments are relatively fixed, suitable for investors seeking stable returns.

• Lower risk: Especially for government bonds or policy-based financial bonds with high credit ratings, the risk of default is low.

• Diversification: It can be combined with other assets such as stocks to reduce the volatility of the overall investment portfolio.

Disadvantages

• Interest rate risk: When market interest rates rise, bond prices generally fall.

• Credit risk: The issuer may default, resulting in failure to repay principal and interest on time.

• Inflation risk: Inflation can erode the real purchasing power of fixed income.

Case

During economic downturns, investors often increase their allocation to government bonds as a safe haven. For example, at the beginning of the global pandemic in 2020, the yield on the 10-year US Treasury bond briefly fell below 0.5%, causing prices to rise sharply, making it the preferred safe haven for investors. On the other hand, high-yield bonds (junk bonds), while offering higher interest rates, also carry a significantly increased probability of default, necessitating careful assessment of credit risk.

Summarize

Bonds are financial instruments that combine financing and investment functions, and they play a crucial role in a robust investment portfolio. Investors should select appropriate bond types based on their risk tolerance, return objectives, and market conditions, while also paying attention to key risk factors such as interest rates, credit risk, and inflation.