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BONDS

Pottery Horizons is premised on the belief that financial education is a bedrock of sustainable, healthy and mature economies. We equip readers with information required to make better and informed decisions in financial markets.

EDUCATION REPORT

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EDUCATION REPORT


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BONDS

Bonds are the general term (often misapplied) used to describe fixed-income assets. These are simply assets (think of possessions that can be sold) that are expected to pay a certain amount of money periodically, thus the term fixed-income.

TThe bond market, although lacking the excitement of the stock market, is actually the larger of the two and is heavily relied upon by governments to finance spending on various projects like construction of roads, hospitals and paying civil servant salaries.

Governments and companies issue bonds in order to finance various activities, as mentioned already. An investor borrows money to an entity and usually expects interest payments in exchange, as well as the initial amount borrowed.

What makes bonds unique is their ability to be traded after being purchased. This is one of the reasons bonds are a cheaper form of financing, their liquidity (we’ll get to the meaning of that soon) makes it possible for the initial buyer to offload it whenever they feel like.

Sounds very much like a loan, doesn’t it

Side Note: Liquidity refers to the “ease” with which something can be bought or sold immediately.

How do Bonds Work and why are they Issued?

EDUCATION REPORT



This is current price of the bond and is unique because it is quoted per nominal value of bonds

held.

Interest payable to bond holders. This will usually be quoted in percentage (5%) and can be paid semi-annually

or annually

Date on which bond will be redeemed and

nominal value will be given to the bond holder

Amount on which interest will be paid and amount that will eventually be repaid. Also termed, par value of bond

Example: Price of a bond is £120 for each £100 nominal

Nominal Value

Redemption DateCoupons

Price

most bonds will share some features listed below.

There are several unique characteristics that specific bonds have and these will be discussed in future text.

EDUCATION REPORT



Governments that wish to finance spending and investment plans issue these out. This is also commonly used when tax revenues are significantly lower than government spending.WWestern government are large issuers of debt and thus usually tend to have high debt to GDP ratios that have run up to 90% for the UK in the past (2012).

Government Bonds

Different governments have different names for bonds but the most unique (and discussed) would be the gilt (UK), bund (Germany) and Treasuries (US).Government bonds often pay lower coupons than corporate bonds due to the increased likelihood of repayment.

These bonds are similar to straights but will have a redeemable range. This means the issuer can redeem the bond once the first date is reached.

These bonds will appear as such: 4% Treasury Stock 2015-2018

TThis means the issuer can redeem the bond from a specified date in 2015 and will usually do so if the cost of borrowing is less, thus “refinancing” its debt at a cheaper rate.

IIf the cost of borrowing stays the same or reduces, then the issuer has no need to redeem the bonds until the latter date.

These bonds carry a fixed coupon and a single repayment. They are what financiers would call a “plain vanilla” product, as they’re pretty straightforward and have little or no strings attached. These make up the majority of bonds in issue.

SSide Note: Straights are most likely going to be expressed in such format: 5% Treasury Stock 2016

This simply means the bond pays a 5% interest on the nominal value every year on a bond that will be redeemed in 2016

Dual-Dated Bonds

Straights or Conventional government bonds

EDUCATION REPORT



Corporate Bonds

A corporate bond is a bond issued by companies.

These vary from commercial paper (short-term bond) to longer-term debt with maturities of at least 12 months.

LLoads of corporate bonds are listed on the major stock exchanges but the majority of bond trading goes on over-the-counter (OTC).

Side Note: stock exchanges are mediums by which investors buy stocks and bonds.

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