Bonds

Bonds are securities representing any loan made by the issuer of the bond (typically a company, public entity or a country), which can be subscribed by investors in shares (par value) of the total loan. Bonds are an asset for investors and a liability to the issuer. In case of bankruptcy or liquidation, the right to repayment of the bond prevails over the shareholder.

A bond is a way of financing in which the issuers (companies, public entity or a country) choose to issue bonds, allowing the investor to participate in direct lending through a loan.

Investors receive a fixed return or variable payments through, usually annual or semi-annual interest (coupon) and the return of the nominal amount outstanding at maturity. The yield on interest and repayment of par value (face value of the title being on the same value that affects the rate of return of the loan) in debt, is usually the main reason for the investment decision. The yield to maturity is called Yield to Maturity (YTM).

The face value of bonds can be called at Par, with the subscription amount or issue price (value at which the bonds are purchased in the primary market) may differ from face value. If the conditions of the bond are attractive to the market, the issuer may decide to sell them above face value, saying that the bonds were issued above par. Conversely, bonds issued at a price lower than the nominal value, it is said that the bonds were issued below par.

Example:

  • The investor X purchased a bond with a maturity of 5 years, with a coupon of 4.65% and an issue price of 95% (under par);
  • Disbursing today 95% of the face value at maturity and receive 100% (add real value of (100% - 95%) / 95% = 5.26% of the amount initially invested);
  • Receiving annually until maturity (5 years) coupon yield of 4.65% on the nominal value (not the amount invested).

The buyer of the bond can sell at any time and the price will be set as a percentage of face value. If the value is greater than 100% means that the investor will be selling at a premium (above the face value or premium), if less than 100% means that the investor is selling at a discount (below par value, or discount). Assuming that the buyer gets the same obligation to maturity, the return on your investment will be composed of the sum of the value of the coupons and the difference between the purchase price and the par value to be repaid at the end of the bond.

 

Features of Bonds:

  • Issuer: the borrowing entity by issuing a bond;
  • Base Currency: currency in which the bond is issued and may be a different currency to the country where the bond is issued.
  • Face Value: face value or “par”, is commonly referred to the amount paid to a bond holder at the maturity date, given the issuer doesn't default. However, bonds sold on the secondary market fluctuate with interest rates.
  • Value Subscription: Value by which the bonds are purchased in the primary market.
  • Reimbursement Value: The reimbursement value is that which the investor will receive at product maturity. It results from the sum of the Nominal Value with the Variable Return, possibly limited by the maximum and minimum return established.
  • Dates and terms - Information on dates clarifies the subscription period (period that precedes the start of the “life” of the bond; favourable moment to invest), the settlement date, the date of reimbursement and the term of the bond (period between these two dates).
  • Interest rate (coupon rate): Interest rate applied to the face value of the bond to give the value of the periodic interest. The interest rate may be fixed rate, it means it remains unchanged during the maturity of the bond or variable (interest rate (1.5%) indexed to Euribor 3m, being known to the coupon but depending of Euribor 3m), wherein the interest rate may vary during the maturity of the bond.
  • Capital gain: If an investor buys a bond at par value and holds it to maturity, there will be no capital gain on the transaction. However, if an investor sells before maturity and generates a profit from the bond, then there is a capital gain.

Risks:

Liquidity Risk: The bonds are marketable securities; its liquidity is realized through trading in the secondary market. Dif Broker may not be able to guarantee a certain sale price.

Issuer Risk: When buying bonds receive the interest associated with the coupon on the dates indicated in the data sheet. At maturity, you will receive the par value plus the last coupon of the bond (defined at the time of issuance of the bonds). However there is a risk of the issuer defaulting in question, not paying the coupon and / or not returning the nominal value. In this case, what should happen naturally will be the bankruptcy of the issuer in question. The main risk of investing in bonds for investors who intend to keep the bond to maturity is the possibility of default of the entities that issue bonds.

Interest Rate Risk: In times of high volatility of market interest rates, the fixed rate bonds tend to be less safe than the floating rate. If interest rates rise, a fixed rate bond loses value because the compensation may fall short of what the market demands. In variable rate an investor must be aware that rate is indexed, but not all indexes follow the same directions.

Market Risk: Possibility of changes in prices on the secondary market, and losses before maturity.

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