A bond is a simple loan made by a creditor to a business, the national govt, or regional or territorial authority. You, the investor, are usually paid with a fixed interest rate for the loan’s length. They may give stability to a well-diversified equities portfolio by delivering a consistent income stream.
How does a bond work?
A bond is an economic instrument that reflects a loan issued to a borrower by an owner called the bondholder. Businesses, national countries, governments, and state authorities offer frequent bonds to support activities and special initiatives.
The borrower returns the loan, generally, a long-term arrangement (ten years or more for state financing), when it expires. However, as a creditor, you will typically get a predetermined rate of return, or dividends, on the lent amount, commonly referred to as the actual or nominal price.
Bonds offer a higher dividend instalment paid twice a year. Some even make payments regularly, while others pay interest every year. Others, known as negative bonds, do not make payments regularly. The dividend payout on these securities is provided as an inflated rates discount.
There are several types available in the financial market. We usually hear of State Treasury, State Government and Municipal Bonds. In some cases, countries may offer each other international bonds as part of a trade agreement. Finally, some very large companies may offer Corporate Bonds.
Advantages and Disadvantages
Investing in bonds is generally safe. They can also act as stock stabilizers. They provide a steady stream of limited income. A large number of issuers available allows for adequate diversification. Financial assets particularly US Treasury are self-lubricating.
Unfortunately, they are financial in nature and thus there is a chance of financial defaults. For international investors, erratic exchange rates can be disadvantageous. Since the 2008 financial crisis, their yields have been meagre. Thus making them less attractive to long-term investors.
Any investor should consider bonds as part of their investment portfolio. They offer diversity and a small steady income stream and are almost risk-free. Read more about other asset classes in our article on investment types.