What are bonds
What are bonds?
Bonds are also included in the securities, as are equities, derivatives and investment funds. Basically, you lend money to states or companies and receive interest on it, so you basically lend. For this reason, bonds are also referred to as “fixed-income securities” or “interest securities” for short. So with bonds, you make money by paying interest on a regular basis. At the end of a certain term, you will receive your money back (= nominal value repayment). Debtors with poor solvency (= creditworthiness) have to pay higher interest rates in order to attract investors. This applies, for example, to crisis states or emerging markets (developing countries such as India or China).
However, bonds are fundamentally different from equities in many ways. First, bondholders are creditors of the company and are entitled to interest and repayment of capital. Second, in the event of bankruptcy, creditors have legal precedence over other beneficiaries and are only compensated when a company is forced to sell assets in order to repay them. Shareholders, on the other hand, are in last place and often receive nothing or only pennies on the dollar in the event of bankruptcy. This implies that equities are inherently riskier investments than bonds.
How is the bond yield calculated and what is the risk
The interest rate of a bond depends to a large extent on its default risk. The higher the risk of non-payment, the higher the interest rate of the bond. In this case, the interest rate is considered as compensation for the risk. A change in the general market situation may also improve or worsen the position of the bond on the market, which may lead to further gains or losses.
For example, a bond is issued at an interest rate of 5%. During the term of the bond, however, the prevailing market interest rate decreases, prompting banks to reduce the interest rates they offer. This means that the bond you are buying now has a better interest rate than other products. This allows the purchased bond, which has gained in value, to be resold at a profit before the actual due date.
Instead of the market interest rate, news about the ise-emitting company can also raise the price of the bond. For example, if a company writes better numbers itself, the risk of the bond also decreases. In the same way, the price of a bond may fall.
Corporate bonds and government bonds have different risks. They cannot all be described as safe or all as risky. Bonds issued by the Federal Republic of Germany, for example, tend to have low interest rates because they are very safe. Governments are at their disposal with their full economic power, and this is high in Germany as one of the world’s leading economies. The probability that Germany can and will repay the bonds is almost 100%. Other countries, such as some Southeast Asian or South American countries, cannot offer such a high probability. Accordingly, the risk of losing bonds in these countries is higher, as is the interest rate.
The same applies to corporate bonds. While medium-market bonds have higher risks and thus higher interest rates, corporate bonds are the reverse. Convertible bonds and subordinated bonds, for example, have their individual opportunities and risks.