Bonds

In summary, a bond is:
- a loan of a specific amount (par value or face value)
- for a specific period (the maturity)
- it pays a regular fixed interest on the loan (the coupon)
- the issuer promises to return the par value when the bond matures (redemption)
- if it is sold before the maturity date, the par value may or may not be realised

It seems to me that bonds, in investment terms, have been somewhat misunderstood by the average saver and investor in Ireland.

The main confusion appears to be with insurance company investment products, such as those products called “investment bonds” and “with profit bonds”. These particular products can be made up of a combination of investments from a range of asset classes.

In strictly financial definition terms these are not “bonds” at all.

So, correctly, a bond is a loan.

Bonds are a single, distinct asset class. The bond purchaser does not buy any equity in whoever is issuing the bond – it is purely a loan to a borrower.

The loan can be to Governments or to Companies. Loans to Governments are normally called Treasury Bonds or Government Bonds. Loans to companies are normally called Corporate Bonds.

Individual Bonds to Governments or companies would be uncommon investments for the average investor in Ireland.

Elsewhere, such as the UK or USA they would be far more common. Particularly as a separate & additional asset class in a balanced investment portfolio. This is their most appropriate function under most circumstances.

Irish investors would be more familiar with bond funds, which would usually be available from life assurance companies here. Bond funds are collective investments of a range of individual bonds of varying maturities, yields and quality ratings. Bond funds are a completely different investment to individual bonds, for a number of reasons. That will be a story for another post.

Back to individual bonds.

An example: a bond could have the following:
- face value, or par value: could be any amount, but let’s say it’s €1000
- coupon: is the rate of interest paid on the face value, let’s say 4%
- maturity date: could be any time interval, let’s say 5 years

In this case the bond holder lends the bond issuer €1000 for 5 years.

The issuer promises to pay the bond holder 4% on the €1000, ie €40 on the anniversary of each year for 5 years.

The issuer also promises to return the €1000 to the bond holder at the end of the 5 years.

Bear in mind, these are promises rather than a guarantees, and they are as good as the government or company making the promises.

It’s that simple.

Things get a bit more complicated if the bond holder decides to sell the bond before the maturity date. The bond holder can do this if there is a ready market for the bond, which there will be for most Government bonds and many large company corporate bonds. But the seller won’t necessarily get €1000 for the bond! And of course there will be the trading fees!

They are an excellent conservative, income-generating, investment and also work well in balancing a portfolio.

The good news is, bonds are available to the average investor in Ireland, and I will write a post on that topic soon.

Comments very welcome.

Related posts:

1. Bond Prices – How Do They Work?
2. Buyers Keepers
3. Absolute Return Funds – Why Medium to High Risk?
4. Personal Retirement Bonds
5. Absolute Return Funds