BONDS

Bonds are one of the most widely used investment instruments by governments, corporations, and other entities to finance their operations or projects. When buying a bond, the investor lends money to the issuer in exchange for periodic interest payments and the return of the capital at maturity. In this article, we will explore in detail what bonds are, their characteristics, advantages, disadvantages, and types.

📌 What is a Bond?

A bond is a type of investment that represents a loan granted by the investor to the bond issuer. Issuers can be governments (government bonds), companies (corporate bonds), or supranational entities. When purchasing a bond, the investor receives a document specifying the loan amount (face value), the interest rate (coupon), and the bond's maturity date.

📌 Characteristics of Bonds

1. Face Value: The amount of money the issuer agrees to repay the bondholder at maturity. Bonds are usually issued in standard amounts, such as 1,000 or 10,000 units of the corresponding currency.
2. Interest Rate (Coupon): The interest the issuer pays the bondholder, expressed as a percentage of the face value and paid at regular intervals (annual, semi-annual, or quarterly).
3. Maturity Date: The date on which the issuer must repay the bond’s face value to the holder. Bonds can have short-, medium-, or long-term maturities, ranging from a few months to several decades.
4. Credit Rating: Bonds are evaluated by rating agencies, which assign a grade based on the issuer’s ability to meet payment obligations. A high rating indicates low risk, while a low rating suggests higher risk.
5. Secondary Market: Bonds can be bought and sold before maturity, allowing investors to trade them. Their prices fluctuate depending on interest rates and economic factors.

📌 Advantages of Bonds

1. Predictable Income: Bonds provide regular interest payments, attractive for those seeking stable income, such as retirees.
2. Diversification: Bonds help diversify a portfolio, reducing overall risk. They often show a negative correlation with stocks, providing stability during market volatility.
3. Lower Risk: Compared to stocks, bonds are generally considered safer investments, especially those issued by stable governments.
4. Inflation Protection: Some bonds, like inflation-linked bonds, protect purchasing power by adjusting payments and principal with inflation.

📌 Disadvantages of Bonds

1. Limited Returns: Bonds usually offer lower returns than stocks, which may not suit investors seeking aggressive growth.
2. Interest Rate Risk: Bond prices are inversely related to interest rates. When rates rise, bond values drop, potentially causing losses if sold before maturity.
3. Credit Risk: The issuer might fail to meet payment obligations, leading to partial or total investment loss. Bonds from lower-rated issuers carry higher credit risk.
4. Inflation Risk: Fixed-rate bonds may lose purchasing power if inflation rises significantly, as their interest payments remain unchanged.

📌 Types of Bonds

1. Government Bonds: Issued by national governments, generally considered the safest. Examples include U.S. Treasury bonds or sovereign bonds elsewhere.
2. Corporate Bonds: Issued by companies to finance operations or projects. Risk and return vary depending on the issuer’s financial health.
3. Municipal Bonds: Issued by local or regional governments to fund public projects. Their interest is often exempt from federal, and sometimes local, taxes.
4. High-Yield Bonds (Junk Bonds): Issued by lower-rated companies, offering higher interest rates to compensate for higher default risk.

📌 Conclusion

Bonds are valuable investment tools that offer an alternative to stocks and more volatile assets. With their unique features, advantages, and drawbacks, bonds can be an essential component of a well-diversified investment strategy. Before investing, it’s crucial to evaluate your risk profile, financial goals, and factors like interest rates, inflation, and issuer creditworthiness. With proper understanding, bonds can help investors make informed decisions aligned with long-term financial goals.

📌 Our Strategy

As investors, in the illiquid part of our portfolio, we aim to maximize returns, but that is not always the safest option. We use bonds mainly as a diversification tool to balance risk.