What are bonds? bond is a type of debt security that requires the issuer to pay the bondholder a specified amount of interest, usually over a specified period of time, accompanied by having to repay the initial loan amount (called the bond’s par value) at maturity.
The nature of the issuer is an important feature of a bond. There are 2 main types of issuers: Government (Central and local) and companies. The government is the most reliable issuer because it has the highest guarantees of principal repayment and interest payment.
In the enterprise category, there are many types of issuers. Each has a different ability to meet obligations agreed upon with the lender. In other words, it can be considered that the payment risk of government bonds is zero, while different corporate bonds have different levels of payment risk.
Of the two types of bond issuers, the government is considered to be more reliable due to the constraints to ensure the highest repayment of principal and interest. Generally, government bonds are considered risk-free security.
For corporate bonds, the issuer divides them into many smaller classes, each of which will have a different ability to meet the obligations committed to the borrower. In other words, depending on the type of corporate bond, there will be different levels of risk in the repayment of principal and interest.
Term of the bond
The term of a bond is the amount of time (usually years) for the debt to cease to exist. This period is known as the bond’s maturity. At maturity, the issuer must recover the bond and repay the principal loan.
Generally, bonds with maturities from 1 to 5 years are called short-term bonds; from 5 to 10 years are called medium-term bonds; over 12 years are long-term bonds.
The maturity of the bond is an important feature, it will indicate the Time period to receive the periodic interest payments. The interest rate of the bond is high or low depending on its maturity, and the price of the bond will change over its life as market interest rates change, the price volatility of a bond depends on its maturity. Assuming other things are fixed, the longer the maturity, the more volatile the bond’s price is to changes in interest rates.
The Par value of the bond and the coupon rate
Par value, also known as “Nominal Value,” is the principal amount of a security, insurance policy, or currency. This is the value that the issuer assigns to security and is indicated on that type of security.
The bond par value is the principal amount written on the face of the bond. This is the amount that the issuer will repay to the bondholder at maturity.
The coupon rate is also known as the nominal interest rate. This is the interest rate that the issuer agrees to pay periodically and throughout the bond holding term. This interest rate is multiplied by the face value of the bond to get the periodic interest that the bondholder receives.
Normally, all types of bonds pay coupon interest annually or twice a year, except for zero-coupon bonds. This type of bond is quite special, the buyer will be able to buy it at a price much lower than the face value. At maturity, the interest received is the difference between the par value and the initial purchase price.
Bond classification with registration form
A bearer bond is a type of bond that cannot bear the name of the bondholder, both on the face of the bond as well as on the issuer’s books. This type of bond will be attached with certificates, when it is due to pay interest, the bondholder just needs to tear it up and bring it to the bank to receive interest. When the bond matures, the bondholder takes the bond to the bank to receive the loan back.
A registered bond is a type of bond with the name and address of the bondholder clearly visible, both on the face of the bond and on the issuer’s books. The form of registration can be done for the entire principal and interest or only for the principal.
The type of fully registered bond that is growing in popularity is the book bond, which has no physical form (bond sheet) instead, ownership is established by keeping the name and address of the bondholder on a computer system. In the Vietnamese stock market, these transactions are managed by the State Securities Commission.
These are bonds issued by the government. Bonds are one of the debt instruments the government uses to cover the budget deficit; finance public investment works or acts as a regulatory tool in monetary policy. Government bonds are considered risk-free security and are also highly liquid. Because of this feature, the coupon interest rate of government bonds is considered the standard to use as a basis for determining the interest rates of other debt instruments with the same maturity.
These are bonds that are issued to raise capital for specific purposes, usually to build infrastructure or public welfare works. This type of bond can be issued by a central government or a local government.
Corporate bonds are bonds issued by companies for the purpose of borrowing long-term capital. Corporate bonds have the following features:
- Interest is paid periodically, principal is paid at maturity. There are also companies that will issue zero-coupon bonds.
- Bondholders are not allowed to participate in company decisions
- When the company declares bankruptcy, it is given priority to pay before shares
- There are specific conditions attached, or there are forms of guarantees.
Corporate bonds are classified into many types, specifically:
- Secured bonds are bonds backed by specific collateral. Bondholders of this type of bond are highly protected, when the company goes bankrupt, they have the right to claim debt with a specific asset (usually real estate, the company’s fixed assets, etc.)
- Unsecured bonds are those that are not secured by anything other than the company’s reputation. The holder of this bond is entitled to interest settlement after the holder of the secured bond but before the shareholders in the case of a company’s bankruptcy. Convertible unsecured bonds allow the holder to convert the bonds into the issuing company’s common stock. The transition time might be set at a specific time or agreed upon at any time.
Despite the fact that they are classified into different types, all of the above bonds have one thing in common: bondholders can know when and how much they will receive payments in advance. There are, however, bonds with specific features, and investors in these bonds will not be able to estimate the returns precisely, such as Floating-rate notes, callable bonds, putable bonds, and convertible bonds.