Each of us had situations when the financial situation worsened and it was necessary to borrow money. Not only individuals need additional funds, but also organizations and the government. A bond is one of the methods of increasing capital. It has a lot of advantages, so you should familiarize yourself with it in detail.
Definition of a concept
A bond is a financial instrument that secures the right of its owner to receive from the issuer of a security its face value or other property equivalent within the prescribed period.
Bonds also imply the right of their holder to receive a fixed interest calculated on the basis of face value. It will be income. In simple terms, a bond is one of the types of securities that confirm that the issuer has borrowed money from the holder.
Types of bonds
There are several types of bonds.
- Income Payment Method. Bonds are divided into interest and discount. In the first case, the issuer pays interest, called coupons, over the life of the security. On domestic exchanges, this option is the most common.
- Discount bonds issued below face value bonds. In this case, they are paid at face value. The profit of the holder of the security is a discount, that is, the difference between the issue price and the face value.
- By type of bond issuer. Securities of this type are corporate, municipal and state. In the first case, bonds are issued by joint stock companies, as well as LLC. The second type of securities is offered at the oblast, city or district level. The Ministry of Finance of the Russian Federation issues government bonds.
- Eurobonds. This type should be considered separately. Financial instruments are issued by issuers to generate income in foreign markets. They are denominated in the currency of another state. The Ministry of Finance of the Russian Federation and domestic companies issue bonds of this type, which are mainly denominated in US dollars.
general characteristics
The economic essence of these securities is similar to lending, but does not need to formalize debt security. In addition, the process of transferring claims to the new owner has been greatly simplified. It should be noted that bank bonds have a similar feature. These financial instruments are more valuable than stocks, as they allow you to get a pre-emptive right when returning money in the event of liquidation or bankruptcy of the issuer. High reliability of bonds makes them much more relevant for investors, which leads to their wide range.
For the issuer, a bond is an additional source of income. Their release is mainly targeted. It consists in financing facilities or programs whose profits will become a source for payments. Typically, bond profits exceed the amount of income from bank deposits in the same amount. On the secondary securities market prices for these financial instruments are formed, the basis for which is a comparison of their profitability and the percentage of the loan.
Bond properties
Examining bonds in detail, it is worth knowing that they have the following properties:
- holders of securities have priority in making a profit;
- the transaction has a specific validity period;
- bonds differ in the amount of payments and frequency;
- bondholders are given the primary right to satisfy their financial claims in the event of bankruptcy or liquidation of the company.
Loan bonds are the main tool for borrowing financial resources, which can be issued by the following structures:
- government bodies;
- the government;
- corporations and companies;
- municipal institutions.
Regardless of the entity that issues the bonds, they have similar properties.
Bonds Features
Bonds have several features that should be considered without fail. The parameters of their release are considered:
- face value of financial instruments;
- loan issue volume;
- profit margin;
- debt repayment periods.
The type of securities under consideration has a certain maturity, according to which they are divided into:
- short-term bonds (up to five years);
- medium-term (up to ten years);
- long-term bonds with a maturity of more than 10 years.
Securities of this type perform such functions in the financial market:
- the source of financing the budget deficit, regardless of its level;
- source of costs of public authorities;
- a source of financing deposits of joint-stock institutions;
- forms of savings of funds of companies, financial institutions and the public;
- provide profit.
In world practice, there are a huge number of types of bonds. These tools allow you to set individual requirements for the transaction, on the basis of which one market participant agrees to provide capital to another. The issue of bonds depends on their type and most often involves the establishment of conditions of interest to a particular group of creditors.
Ways to pay bond income
World practice involves the use of one of several methods according to which the repayment of bonds is performed:
- stepped interest rate;
- fixed interest payment;
- floating rate of interest income;
- sale of securities at a discount;
- face value indexing;
- holding winning loans.
It is worth noting that the most simple and relevant form of paying profit is the installation of a fixed interest payment. A stepped interest rate implies the determination of several dates, after which the holder has the right to fully repay or extend them until the next date. In this case, the rate will increase in each subsequent period of time.
If the interest rate is called floating, then it is regularly changed. The procedure is carried out in accordance with the dynamics discount rate Central Bank or the degree of return on government securities. It is worth noting that in some countries a bond issue with a face value is provided, which is indexed taking into account an increase in the consumer price index, which is carried out as part of an anti-inflation policy.
There are types of bonds that do not provide for the payment of interest. Their holders make a profit by buying at a discount and paying off at par. Special circulations may also be held that allow bondholders to receive income in the form of winnings.
Profitability Definition
The yield of bonds differs in certain parameters. They depend on the conditions proposed by the issuer. Securities that are redeemed at the end of the term provide for measuring the yield of the following types:
- coupon;
- current;
- complete.
Coupon and current yield
Coupon yield is the interest rate specified in the document and paid by the issuer for the coupon. At the same time, payments can be made once every three months, six months or once a year.
The current yield of fixed rate bonds is the ratio of recurring payments to acquisition costs.The indicator is able to characterize the paid annual interest on capital. However, the current yield does not take into account changes in the value of bonds over the period of their storage.
The considered indicator is capable of changing according to the prices established in the market. It is worth noting that it becomes fixed from the moment of acquisition, since the coupon rate does not change. In addition, bond prices and yields will be higher for discounted securities.
The current yield indicator does not provide for accounting for the exchange rate difference between the acquisition and redemption prices. For this reason, it cannot be used to compare the effectiveness of transactions with certain initial conditions. In order to determine whether it is advisable to invest in bonds, it is worth using the yield to maturity indicator.
Yield to maturity and full yield
Yield to maturity is the interest rate taking into account the discount coefficient. It sets the difference between the current and market value of the payment stream. You can determine the yield to maturity during storage, bonds are held until maturity.
Due to the full yield, the price of the bond and all possible sources of income are taken into account. This indicator is often called the rate of the room. With its help, you can determine how effective the purchased security will be. Thus, you can not make a mistake when concluding a transaction and make a profitable investment. The definition of profitability will be useful both for individuals and legal entities, as well as for companies and municipalities that purchase the securities in question.
