There are several securities that traders can invest in, in the stock market. Bonds are one of such security. We understand that getting to know more about the different types of securities can confuse you, but here is everything you need to know about bonds as a means of investment, the benefits they can yield, their types and the possible risks they pose.
Understanding Bonds
Bonds are a type of debt securities that help companies or even governments raise capital for their growth and provide a means of investment for investors and traders. Bonds are usually issued by governments or corporations when they require capital to fund large projects.
So, as a trader, when you invest in bonds, you are essentially lending money to the bond meaning issuer with the promise of gaining periodic interest payments from them.
Bonds come with a maturity date that tells the trader when the bond will expire and when they can expect the full repayment of the loan they had given.
This expiry date could range from a year to up to 30 years. Since bonds provide the investor with a regular income, offering them a steady cash flow, these are called fixed-income instruments.
Advantages and Disadvantages of Bonds
To know whether or not investing in a bond is conducive to one’s portfolio growth or not, it is important to understand the advantages and the disadvantages that they hold.
Benefits of bonds
- Bonds are less volatile when compared to many other investment options like stocks, and help offer more stability.
- With their fixed-income nature, traders who have invested in bonds enjoy regular income from the interest payments that the bond issuer provides the investor.
- Once the bond matures, traders also gain the entirety of their investment back.
Risks of bonds
- One of the main risks with bonds is the default risk that they hold because if the bond issuer defaults, a trader might not get their principal amount back either.
- Though bond prices are not particularly volatile, any changes in the interest rate could end up affecting their value.
- The chances of the value of the interest offered by the bond issuer eroding, due to inflation are also high.
Bond Types
There are two main types of bonds; government bonds and corporate bonds. To know which one to invest in depending on your financial goals, here is everything you need to know about both of them.
Government Bonds
- These are issued by governments at any level.
- Helps the government fund large projects like those for infrastructure development.
- The bonds that are issued by developed countries like the USA or Canada are considered safer as the chances of defaulting are lower
- Bonds by the governments of emerging market countries are considered to be riskier but could offer investors higher returns.
Corporate Bonds
- Issued by companies or corporations to raise funds.
- There are two types of corporate bonds; investment-grade bonds and high-yield bonds.
- The former is issued by financially stable companies, making them less riskier
- The latter is riskier as their chances of default are high.
Factors that Affect the Price of Bonds
There are certain factors also that could end up affecting the price of bonds. Here is a list of some of them.
1. Interest rates:
With lower interest rates, provided by the central banks, bond prices can go up and conversely, an increase in the interest rate leads to falling bond prices.
2. Economic conditions:
When there is economic uncertainty in the country, market volatility increases, leading investors to invest more in bonds than stocks, pushing the prices of bonds up.
3. Credit ratings:
It is important to check the credit rating of the bond issuer before investing in a bond. Bond issuers with a downgraded credit rating will usually have lower bond prices. Investors can get their hands on a bond issuer’s creditworthiness through bond rating agencies.
Conclusion
Bonds can be a great means of investment when you take all the aspects discussed above into account and make an informed decision. Bonds are not to be confused with debentures.
There is a lot of difference between bond and debenture and investors must do their due diligence before zeroing in on the one they think would prove to be most beneficial for them.