What is a Bond?

investment in bondsA bond is a debt instrument. At the time of the purchase it is known the exact profitability the investor is going to get for that investment. Companies issue bonds to finance new projects or to renovate already existing projects, in exchange of a future money return to the investor.

The return on bonds depends on the strength of the company. Basically, the return of a bond depends on the likelihood that the issuer of the bond (state or corporation) gives the money back. Safer bonds, and therefore less profitable, are generally issued by states. The bonds issued by large companies are slightly more profitable than those issued by states. As the strength of the company is lowering, profitability is increasing, reaching the so-called “junk” bonds, which are really at risk for default.

In practice, the bonds issued by most listed companies have no danger of not being charged, but there are small differences in price. The reasoning is, roughly, the following: equal return on 2 different bonds, prefer buying a government bond that one of General Electric. So General Electric bonds have to be slightly more profitable (a few tenths or hundredths of a point) that the United States Bond for example. Similarly, to equal profitability I prefer to buy a General Electric bond than one of Wal-Mart, and that’s why Wal-Mart’s bonds are likely to be more profitable than General Electric.

Depending on the Duration of the bond, it will have some peculiarities on the way it is dealt. So, with bonds with a duration of more than one year we get what it’s called a Coupon. This coupon is a monetary value in a percentage (%) relation to the capital we paid for the bond.

If a bond is held to maturity then the investor will receive the exact amount agreed at the time of the purchase. But, if sold before it reaches maturity then can get a lower or higher than expected profitability. The longer time remaining to maturity of the bond the more is increased the influence of fluctuations in interest rates in the bond price.

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