Unlike the stock that gives ownership to the holder, the bond is actually a loan you give to a company. Bonds are long-term debt issued by a company or government with a nominal value (par value / par value) and a certain maturity. Because you are giving a loan to a company or a government, the borrower (the company or the government) will repay the loan plus the interest for a certain period of time.
Coupon bonds with fixed interest rates during the period of validity are among the types of bonds traded in the capital markets of several countries today.
Bonds are a type of long-term investment. The capital to be spent on bond investments is relatively large enough for individual investors. The value of bonds that are traded is usually in units large enough, for example $ 1 million. The period of validity of the bond depends on the institution or body that publishes it, generally between 5 to 10 years. The shorter the duration of bonds, the less the effect on the interest rate. The longer the duration the more sensitive to changes in interest rates. You can sell the bonds you have on the other hand in the secondary market in accordance with market value or price before the bond matures.
Changes in bond prices in the market are strongly influenced by changes in interest rates and perceptions of risk. Bond prices in the stock market may be higher or lower than their par value. Investing in bonds not only benefits from fixed interest (coupon) payments, but you also have the opportunity to profit from capital gains (the difference between buy and sell). A bond may be traded at any time (before maturity) at a price more or less than its par value, depending on market conditions. Anyone who has a bond at maturity will get a refund of the amount of the par value. Bond prices may fluctuate due to several things, such as: the interest rate paid on the bond, the level of certainty of repayment or overall economic conditions, especially the inflation rate that affects the interest rate of the bank.
Generally, the value of bond coupon will be higher than deposit interest, but lower than bank loan interest rate. Bond prices will fluctuate, the magnitude of fluctuations depends on the demand, supply and interest rates that occur in the market. Bond prices are negatively correlated with interest rates. Another factor in the decline in the price of bonds can come from the increased risk of the issuing company. The risk of a default on a bond is reflected in the rating of the bond.
In the prospectus presented to potential investors, a summary of facts and important considerations are presented. For example, regarding the company’s articles of association, the company’s business field includes the nominal amount of the bond and its intended use. Important data such as the latest financial statements are attached thoroughly. Brief history of issuers and shareholders, corporate structure, activities and business prospects. At the beginning of the prospectus will be a summary of a public offering that will explain the identity of the bond.
In general, the longer the time it will be the higher the interest rate offered to cover the additional risk due to the very long investment period. The relationship between the interest rate paid by a bond (short or long term) with the date or year of maturity is called the yield curve. Yield is what investors actually get from the results of paying their money on bonds. Most bond columns represent the current yield (current) in percentage. Investors use the current yield to compare the relative value of a bond.
YTM (Yield To Maturity) is a way to predict profit in a time period. YTM calculates the interest rate on the bonds associated with the price, with the difference in the selling price of the par value, with the remaining years until the bond matures. The value of YTM is determined by three things: the amount of periodic received payment, the cost and the maturity.
Typically, Bonds are issued with the following characteristics:
- The maturity date of the bond, the date set by the borrower to repay the debt. Although there is a due date listed in a bond does not mean you have to hold the bond until maturity, because you can sell it on the bond market.
- The coupon rate of a bond, ie the interest rate to be paid to you periodically. The interest rate may be fixed (the interest paid to you is fixed annually) or the floating rate (the interest paid will be periodically adjusted).
- The face value or par value of a bond is the amount of money lent to the enterprise, this amount which will be the principal of the loan.
As has been said before, bonds can be issued by both companies and governments.
Government bonds have the highest level of security (savereign risk) because the government has the ability to charge taxes and print money. Government issued bonds are commonly known as retail bonds.
But when you decide to choose a corporate bond, always choose from the bond that has the highest rating first. This rating reflects the risk of default in paying interest or principal.
AAA rating has the lowest risk, followed by AA, A, BBB and so on until D indicating that the bond has failed to pay (wanprestasi). In addition to the risk of failure as mentioned above, there are some more risks contained in bonds such as: interest rate risk, re-investment risk and other risks.
Interest rate risk
Bond prices move in opposite direction (negatively correlated) with interest rate movements. As interest rates rise, bond prices fall. The longer the bond maturity date, the higher the interest rate risk in the bonds because the interest rate fluctuations are higher in the long run.
The next risk is the risk of inflation. You should pay attention to the economic condition from time to time in order to observe the movement of the inflation rate. If you look at the possibility of rising inflation, then sell the bonds you hold immediately because if inflation increases then interest rates will also increase. Because if you hold a bond that provides a lower coupon rate, you will lose the purchasing power of the interest you receive.
Another risk is the risk of reinvestment risk. You can not expect the current investment conditions to be the same as when you bought the bonds first, especially when you bought long-term bonds, because economic and political changes can affect the interest rate at the time You want to reinvest the coupons of the bonds. And there are also some types of bonds that feature call, which means the bond issuing company is entitled to buy back bonds at a certain price (call price) before the bond matures. For foreign currency denominated bonds, fluctuations in foreign exchange rates make this risk worthy of attention, in order for your investments to be protected against losses from foreign exchange.
Now you know about bonds, ways and benefits of bond investments, how the bonds are issued and what risks they contain. If you have moderate preferences at risk, you are better off choosing to invest in bonds that provide periodic fixed income.