A bond is a loan agreement by which a borrower pledges to repay the loan principal and possible interest in keeping with the terms of the agreement. Lenders provide loans to borrowers by buying bonds.
On standard bonds, the loan is only repaid when the bond "matures" at the end of the bond term (the loan term). The face value of a bond indicates the amount which must be repaid to the lender by the borrower when the bond matures. The face value of a bond is also know as the par. Depending on the type of bond in question, a bond may be bought at par, below par or above par.
The claim to interest payable on a bond is often referred to as the coupon. This is because physical bond agreements (as opposed to electronic bonds) include coupons which can be removed and redeemed for interest due at specified intervals.
Bonds are widely issued by companies and government agencies as a means of obtaining loans from investors.
There are three main categories of bonds:
- Government bonds: These are issued by government treasuries or government agencies. Teasury bonds, municipal bonds, arbitrage bonds, agency bonds and public bonds are examples of government bonds.
- Bank bonds: These are bond which are issued by banks as a means of raising capital. They perform a function similar to that of fixed deposits, certificates of deposit and medium-term notes.
- Corporate bonds: These are bonds which are issued by private companies as a means of obtaining loans from private investors.
Standard bonds specify a fixed rate of interest which the borrower must pay to the lender on a recurring basis. However, there are many different kinds of bonds which serve many different investment purposes. Some bonds combine features of multiple bond types. Common bond types include:
- Accretion-directed bond
- Accrual bond
- Callable bond
- Convertible bond
- Covered bond
- Extendible bond
- Installment bond
- Junior lien bond
- Partly paid bond
- Perpetual bond
- Reverse convertible bond
- Redeemable bond
- Retractable bond
- Senior lien bond
- Step-up bond
- Straight bond
- Term bond
- Warrant bond
- Zero coupon bond
A bearer bond is a bond agreement which does not specify the name of the lender. Whoever holds a bearer bond has the right to earn interest and receive repayment of a loan. Bearer bonds can easily be transfered between owners, making them a useful tool for trading debt.
Medium-term notes are very low-risk obligations issued by most Swiss banks. Yields are higher than those of a savings account, but your money is tied up over a fixed term of anywhere between one and ten years. You can compare Swiss medium-term notes using the interactive medium-term note comparison.
When you buy a bond, you are in fact providing the public or private entity that issues it with a long-term loan.
As long-term, fixed-yield securities, bonds are also traded on the stock market because the value of bonds can rise or fall if interest rates change. If, for example, a fixed-interest bond is issued at a time when interest rates average 5%, that bond would become more valuable if overall interest rates fell to just 1% because it delivers higher yields than other loans.
In principle, bonds are considered to be risk-free investment vehicles. But in fact, the level of risk associated with bonds depends on the creditworthiness of the entity which issues the bond. If a company or government experienced financial difficulties, they could fail to make interest payments or even default on repayment of the loan. Higher risk bonds normally deliver higher yields.