The popular term
bond as heard or read in the newspapers, television and other kinds of media platforms I believe have brought to many confusion upon trying to research and know more about it. In this post, i would try to make sense of bonds by explaining it in simple terms.
Firstly, what are bonds? To simply put, a bond is a form of investment security that involves giving loan to the government or company i.e. you as an individual is buying part of the debt of the earlier named institutions. It is represented by a simple piece of paper called a certificate or depository. It bears the amount borrowed from you the bond holder, the years the loan would last for, the interest rate and repayment period.
Now, i'm quite sure you would be wondering why you should lend out your money to a multi-million rich company or a revenue generating government. The answer is simple, the bond issuer attaches a coupon to the bond. The coupon is the interest rate attached to the bond issued. So, lets assume that you have some N10m that you are not using again or not using for the time being and this particular bond issuer say the government are willing to raise a debt of N10b for 10years at a coupon of 6% pa i.e. the government wants to borrow N10b from the public and are willing to pay an interest of 6% per annum for the next 10years while at maturity (after 10 years), the principal amount would be paid back. You buying N10m bond means you have borrowed the government N10m out of the N10b they are willing to raise and would be paid an interest of 6% per annum then after 10years your N10m would be paid back to you. It is pertinent to note that the issuer has an option of
call back meaning they would pay back the principal amount before maturity. Though if this provision would be obtainable, it would be expressly stated in the bond prospectus.
How then does an individual buy a bond? This is done in the bond market. As our elementary education defines market, a market is a place where
buyers and
sellers meet. Exactly what is defined above is what happens in a bond market. There are two types of bond market;
(a) Primary bond market
(b) Secondary bond market
The
primary bond market is where bonds just offered by the bond issuer to the public are bought freshly while the
secondary bond market is where tradable bonds are bought or sold. This secondary trade could be done over the counter (OTC) or on the floor of the stock exchange market. The value of bonds just like shares either goes up or come down depending on several prevailing factors. Take for instance a bond bought for say N10m could be sold higher (N11m) or lower (N9m). After which the coupon attached would now be paid to the new bond owner. It is important to note that at maturity, the face value of the bond is what would be paid as the principal amount not the amount at which it was bought.
The term
yield as heard when bond is mentioned is the interest upon
traded bonds. When bonds are traded either at a higher or a lower value, the interest (coupon attached to the bond) divided by the traded value is what is called
yield. The yield on a bond is always in the opposite direction to the value of the traded bond.
Finally, one might want to ask what the difference between bond and shares is. Its quite clear. With bonds, you are only borrowing the issuer money which would be paid back while with shares, you buy into the ownership of the company and would be paid dividend depending on the progress of the company (meaning its not a fixed rate as in bonds). Bond holders are always settled before share holders in a case of bankruptcy or company fold up and this is a major advantage of investing in bonds.
Well, I hope I've done justice to the concept of bond? For more financial news and updates do check our site www.fiinance.blogspot.com frequently or follow me on Twitter: @sosarichards, Facebook: Aiwekhoe Richard Osaro
