A bond is a promise to pay a certain amount of money, at an interest rate and at a future date given. A bond is a debt instrument.
They can be issued by government entities or companies, allowing them in return to obtain financing. In this way, companies can carry out their projects with funds obtained under conditions more favorable than those offered by traditional banking credit.
Bonds are traded on the secondary market, such as stocks, and their price fluctuates, causing losses. Fixed income is only fixed if the bond is held until its maturity.
The issue of bonds allows issuers to be “directly” with the surplus fund agents. In the absence of an intermediary (bank), the interest rate obtained is more favorable for both settlers and borrowers.
They can be bought by individual investors, companies, government, institutional investors, among others. Bondholders are not owners of the company, however in the event that it is settled, they will have priority to recover their investments against the shareholders who have the last priority.
Companies and governments can issue debt, which is placed through an auction (primary market) among investors, where the price of the bond and coupon (interest paid to the investor) are set. For these investors, whenever the issuer does not break and hold the securities to maturity, the money is guaranteed. However, like shares after an IPO, bonds are then quoted on the secondary market and their price fluctuates. In this way, if the investor wants to sell his bonds, he can do so above the initial price (with profits) or below (with losses).
Most bonds pay interest periodically (every quarter or semester) and some are paid at maturity. Periodic payments are known as “coupons”
Generally, bonds pay a fixed interest rate even though there are issues that pay variable interest (for example, the average of the interest rates paid by banks X and Z.
The bonds can be issued to Short, Medium and Long Term. In some markets they are given different names depending on their duration: commercial papers, bills, debentures, or notes when issued in the short term.
High rates are related to higher coupons, but also to declines in bond prices. According to experts, in times like the coming, it is recommended to buy floating coupon debt (payments linked to a rate that rises with rates, such as Euribor), bonds linked to inflation, as they are traditionally stages of rising prices; or hybrids, which are an intermediate title between stock and debt.
Debts with higher credit risk, such as anticrisis or companies with lower ratios (high yield), bear better the rate increases.
It is also common for issuers to agree to the “redemption” or repurchase of bonds at some point before maturity. Usually the redemption is to the “pair” (to the value paid by the buyer when they were issued). they can also be redeemed at a higher price, called calling. This strategy is used when interest rates go down, allowing companies to replace expensive debt with funds obtained at more favorable interest rates.
The price of bonds fluctuates, daily in response to various variables, but mainly to interest rates. The price of the bonds behaves inversely to the interest rate. When the interest rate goes down, the bond price rises, as it is more attractive than other alternatives (pay higher interest rates). vice versa, when the interest rate rises, the price of the bonds falls. The price change is stronger in long-term bonds. The longer the maturity period, the greater the bond will. The price of the bonds is equal to the Present Value of the periodic interest and the principal paid at maturity.
The two main enemies of the debt market are interest rates and defaults. With respect to the former, a rise in interest rates by the competent central bank in the region raises the cost of financing companies, which, when they issue, offer higher returns by making the previously issued bonds less attractive, the price of which falls .
On the other hand, credit risk measures the probability that a company will pay the coupon or even the nominal of its bonds. The worse the credit rating of the issuer (rata), the greater the probability that it will not pay and the investor will not recover its investment.
In this way, investors can know the level of risk associated with the issuer and the bond. Among the best known are Standard & Poor’s, and Moody’s.