Bond is the umbrella term for interest-bearing securities and debt securities made out to the respective bearer. There are public bonds (government, municipalities), covered bonds (bonds from mortgage banks), and corporate bonds (corporate bonds, industrial bonds).
Note: Premium bonds are interest-bearing security (bonds) for which the market value of the title is higher than the underlying nominal value according to the bond conditions.
For a company, a bond is one of the classic means of raising outside capital. Unlike loans, bonds are issued publicly, so anyone can lend capital to the issuer of the bond (also called the issuer). The bonds differ in terms of terms, currency, and interest rate. With a classic fixed-interest bond, the investor receives the interest on his account annually, at the end of the term he then gets the nominal volume or the nominal value of the bond repaid.
Bonds can also be sold on the stock exchange at the current price before the end of the term. Depending on the development of interest rates, terms, and creditworthiness, however, the market price changes in the meantime and – depending on various conditions, such as the creditworthiness of the issuer – can fluctuate significantly and be listed well below the nominal value.
Opportunities & Risks
- Often smaller price fluctuations than with stocks
- Little dependence on stocks – stock prices fall, bond prices rise or vice versa
- More return than possible on the call money account
- Credit risk: there is a possibility that the issuer of the bond will become insolvent
- Yield opportunities are usually as high as with stocks
- Interest rate risk: if the market interest rate changes, this also affects the price of interest-bearing securities
- Price losses during the term are possible
What you should know about bonds:
1. Stocks don’t always pay more than bonds.
Between 1870 and 1940, stocks and bonds still yielded more or less equal returns. Only after World War II did stocks generate higher returns than bonds. Since 1950 z. For example, the stocks of large American companies brought annual returns of 13.4% on average. Long-dated US bonds, on the other hand, only returned 5.9%.
2. You can also lose money on bonds.
Bonds are not a guarantee of returns. While their maturity and interest payments are fixed, hence the term “fixed income” securities, their income is not yet known. They are subject to a number of risks, including the risk of total loss.
3. Bond prices move in the opposite direction to interest rates.
When interest rates fall, bond prices rise and vice versa. However, if you hold a bond to maturity, price fluctuations are not important. When the bond matures, you get your capital back. You will also receive any interest payments due.
4. A bond and a bond fund have nothing in common.
Assuming the creditworthiness of the issuer, you will receive the specified interest payment for bonds during the term. In addition, you get your capital back (less any costs paid, such as front-end loads) when the bond matures, unless the issuer (issuer of the bond) goes bankrupt. With a bond fund, you don’t know beforehand how much it will return. The value of the fund is subject to fluctuations.
5. When you buy newly issued bonds, you save money.
As a rule, you will receive them at the issue price without any additional surcharges. The situation is different for older bonds. The broker charges fees when trading bonds. Under certain circumstances, these surcharges are not insignificant and reduce future earnings.
6. Don’t invest all your retirement savings in bonds.
Inflation reduces the value of the fixed interest payments on the bonds. In contrast, stock returns tend to keep pace with inflation. Young and middle-aged people should focus their investments on equities.
7. Issue an exemption order.
If you order bonds through your bank or broker, you should issue an exemption order at the same time so that the interest income is not fully taxed. The allowance for single people is currently EUR 801 per year (source: Federal Ministry of Finance ).
8. Pay attention not only to the interest but also to the total return.
Yield is a thing in the bond world. You buy a bond with an interest rate of 8%. But if general interest rates rise and the price of the bond falls by 3%, the total return for the first year would be only 5%.
9. Capital gains from long-term bonds.
If you speculate on interest rate movements, you should buy long-term bonds or invest in bond funds. If interest rates fall, long-term bonds will rise faster than short-term bonds. So you get a potentially large return on capital on top of the interest that the bond yield. However, if interest rates rise, you can also lose more accordingly.
The longer you invest, the higher your profit
Typically, the longer the term of a bond, the higher the coupon. The difference between 5-year Treasuries and 30-year bonds is often a full percentage point or two. Because the longer the term of a bond, the longer the owner will receive a low-interest rate in a general rise in interest rates. And the greater the risk, the greater the potential reward.
Likewise, the interest rate that a bond yields is directly related to the level of risk of the bond. The safety of treasury bills can e.g. For example, in the bond world, it’s hard to beat. That’s because the government could print more money to pay them back. But even federal bonds are not immune to the laws of the economy. Should the government print a lot of money just to redeem its bonds, inflation would skyrocket. The bonds would be worth less that way.