What are bonds? | Mintos Investor Academy (2024)

A bond is a debt security, or simply put, a form of “I owe you” (IOU) between a lender and a borrower. Bonds are commonly issued by a government, a government agency, or a company to finance projects or other needs.

In return for lending money to the bond issuer, the issuer promises to pay you a specified interest rate during the life of the bond, and the principal of the bond when it matures. Because bonds have a fixed interest rate, they’re referred to as a type of fixed-income instrument.

Coupon: The annualized interest rate paid to investors. Also called nominal yield.

Maturity: The date when the principal (also known as face value or par value) of the bond is to be paid back to investors and the bond ends.

Security: A bond can be secured or unsecured. A secured bond pledges specific assets, also called collateral, to bondholders if the issuer can’t repay its obligations. Collateral is an item of value, normally money, that a lender can seize from a borrower if they fail to repay a loan according to the agreed terms. Unsecured bonds are not backed by collateral.

Liquidation preference: When a company is liquidated, its creditors are repaid in a particular order. Senior debt must be repaid first, followed by junior (subordinated) debt. Stockholders get whatever is left.

Callability: If a bond has a call provision, it may be paid off by the issuer before maturity.

You can find more information on the key terms for a specific bond offering in the applicable prospectus.

Bond yield: This is the annual income generated by a bond as a percentage of its face value. It’s the interest or coupon payment that a bondholder receives relative to the bond’s current market price.

Yield to Maturity (YTM): YTM is the total return anticipated on a bond if it’s held until maturity. It takes into account not only the coupon payments, but also any capital gains or losses resulting from the bond’s price changes over time. YTM is often considered a more comprehensive measure of a bond’s potential return compared to just looking at its coupon yield or current yield.

Bond Return: Bond return encompasses the total gain or loss an investor experiences from holding a bond over a specific period.

Bond prices and yields have an inverse relationship. When bond prices rise, yields fall, and vice versa. This relationship is because as interest rates rise, newly issued bonds offer higher coupon rates, making older bonds with lower coupon rates less appealing. This lower demand for existing bonds leads to a decrease in their prices. In contrast, when interest rates fall, older bonds with higher coupon rates become more attractive, increasing demand and pushing their prices up.

There are several benefits and drawbacks when it comes to investing in bonds. Each of these should be considered based on your investment goals, risk tolerance, and overall financial strategy.

Pros:

• Regular and predictable income
• Hold the bond to maturity and get all your principal back
• Can help diversify an investment portfolio
• Easy to sell compared to stocks and ETFs
• Considered lower risk investment compared to other assets

Cons:

• Bonds typically pay out lower returns than other assets, like stocks
• There’s a risk that the issuer might default on interest payments or fail to repay the principal amount at maturity
• As interest rates rise, the yield on newly issued bonds increases, leading to a decrease in the demand for existing bonds and causing their prices to drop

Bonds offer stability, income, and risk management benefits. However, they also come with certain drawbacks, including lower potential returns. Diversification across asset classes can help balance the pros and cons and create a well-rounded investment strategy.

Bonds are a great way to help diversify your portfolio. They offer less volatility than stocks and predictable cash flow. Fixed-income assets, like bonds, can satisfy an investor’s need for income even when interest rates are low, despite the fact that they come with some risks, as do most investments. The risk of default, where the issuer is unable to make interest payments or repay the principal, is a consideration when investing in bonds. Private credit rating companies assign ratings to bonds based on their assessment of the issuer’s creditworthiness. Investors can use these ratings to make informed decisions.

Bonds are crucial instruments in the global financial market, serving as vehicles for raising capital, managing risk, generating income, and providing insights into economic conditions. Bonds influence interest rates, currency markets, and government fiscal policies, making them important to the functioning of the broader economy.

When you invest in a bond, you’re lending money to the issuer in exchange for periodic interest payments (known as coupon payments) and the return of the principal amount, also called the face value or par value, when the bond matures. To understand this whole process, let’s walk through how bonds work.

First, the issuer decides to raise funds by issuing bonds. The issuer determines the face value, coupon rate, maturity date, and other terms of the bond.

After issuance, bonds can be bought and sold on the secondary market, also known as the stock market. The market price of a bond may fluctuate based on a few factors including changes in interest rates, credit risk, and overall market conditions.

The yield represents the annual income generated by the bond relative to its current market price. Different types of yields, such as current yield and yield to maturity (YTM), provide insights into the bond’s potential returns.

Lastly, each bond has a maturity date, which is the date on which the issuer agrees to repay the bond’s face value to the bondholder. At maturity, the issuer “redeems” the bond by paying back the principal amount to the bondholder. This completes the bond’s life cycle.

Holding vs. trading bonds

When you buy a bond, you can hold it and collect the interest payments until it reaches maturity. In this case, you won’t be affected by fluctuations in the bond’s value – your interest payments and face value will stay the same.

However, you can also buy and sell bonds on the secondary market. However, after a bond is initially issued, its market price can fluctuate, which will impact the yield of the bond.

Bonds on Mintos are Fractional Bonds. The idea of fractionalization is the division of an asset class into pieces that are less than a full share. When an asset class is fractionalized, investing in that specific asset class is more affordable and convenient for investors. This enables investors to add asset classes to their portfolios that they otherwise would not have been able to afford.

Bonds are known to be difficult to access for investors because they normally require investments in the 5-digit range or higher, and are typically only available in certain countries. We want to provide an opportunity for all investors to benefit from investing in bonds: On Mintos, you can invest in small fractions of bonds, starting from as little as €50.

Each Fractional Bond has a unique International Securities Identification Number (ISIN). Investing in a Fractional Bond exposes you to the linked bond, which serves as the underlying asset for that specific note.

Investors earn returns from the cash flows of the linked bond. The bond issuer makes repayments on the Fractional Bond to the bond issuer, who in turn pays investors who have invested into Fractional Bonds on Mintos.¹