What are Bonds?

With a bond you are lending money to a government or company. In return, you will receive interest in the form of a coupon payment. A bond is therefore a debt certificate and generally regarded as the defensive part of an investment portfolio.

Nominal value, coupon rate and coupon date

The nominal value of a bond is the amount that a government or company aims to collect from the loan. This amount is divided into pieces known as coupons. You can buy them on the stock market, frequently in units of EUR 1000 or multiples of them. If you have purchased a coupon, you will receive interest upon it.  This is often at a fixed rate, but it can also be variable. The interest is always paid on the coupon date. Bonds have a market price that is expressed as a percentage of the nominal value. If the rate is exactly equal to the nominal value, it is 100% or at par. The bond is considered below par value if the stock price is below 100%, and above par if it exceeds 100%.

In addition to the usual corporate and government bonds, there are also convertible bonds, reverse convertibles, zero-coupon bonds and perpetual bonds. These are bonds that may involve a higher risk. We advise you not to invest in these instruments if you do not understand the risks.

Calculation with bonds

We can look at a corporate bond that issues a coupon rate of 6% annually on May 1 with an expiration date of May 1, 2020. This bond currently holds a stock price of 102%. You want to purchase a EUR 1000 coupon from this bond. What do you pay for this purchase, how much interest is added to your account annually and what is your return?

1000 nominal x 102% = 1020. You therefore pay EUR 1020 to purchase one coupon of 1000 nominal. The coupon rate will be distributed to you on the nominal amount held by you. You receive 1000 x 6% annually = 60 euro interest.

Coupon yield takes into account the purchase price of the bond and is 60/1020 = 5.88%. If you also take into account the remaining term of the bond, this is the effective return. It will be slightly lower than the coupon return as the bond will be repaid at EUR 1000 by 2020. Because you bought the bond for EUR 1020, this means a loss of EUR 20 that you should deduct from the interest you receive annually during the term.

Market interest and creditworthiness

When a government or enterprise issues a bond, the interest rate will depend on a range of factors including market interest rates, the maturity of the bond and perception of the market for credit or government credit. The less creditworthy the issuer, the higher the interest rate. The longer the term of the loan, the higher the interest rate.

Once the bond is traded on the stock exchange, market interest rates and creditworthiness can also significantly affect price formation. For example, the rate of a bond may fluctuate considerably due to changes in market interest rates. If the market interest rate rises, the price of the bond decreases and vice versa. Also, the bond rate may fluctuate based on a changed estimate of the issuer's creditworthiness. During the Euro crisis, government bond yields fell in countries such as Greece, Spain and Italy. Investors feared that these countries were unable to meet their obligations.  

Why invest in bonds?

Bonds are suitable for investors who are satisfied with the previously known effective return, provided they are prepared to hold the bond until the end of its maturity. It is especially interesting for those who are looking for higher returns on their savings but  do not feel confident to take the step into stock market investing. Please note: with bonds there is an element of risk, just as with any other form of investment. The issuer (company or government) may be in trouble or even go bankrupt. In this case, your investment will be less valuable, or even lose its entire value.  

Risks

The information on investment products is for general information and is not intended as an advice. In spite of the fact that Binckbank takes care of the compilation and maintenance of these pages, using sources deemed reliable Binckbank can not guarantee the accuracy, completeness and actuality of the information provided. If you use the information provided without verification or advice, do so for your own account and risk. We advise you to always check any transactions and not to invest in financial instruments that you do not understand the risks. No rights can be derived from the information on these pages.