What is a bond [Explained]

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What is a bond

Bonds are securities that represent receivables. A company or government borrowed a loan through a bond. When you buy a bond as an investor, you practically grant the issue a credit which must be repaid to you.

Explain how bonds work

When a company needs money, there are different ways. How this works through an exchange listing and the sale of company shares in the form of shares, I have explained to you in another piece. In the context of exchanges, it is often the case that not only shares but also bonds are spoken. What’s this?

A bond is issued under certain conditions. They have a certain nominal value, as a simple example about 100 euros. A company promises that it gets 100 euros, within five years a repayment of the value plus – as an example – 4% interest. After five years the investor would get back the initial 100 Euro plus interest and interest rate for his bond, which would be again 21.67 Euro. It’s a good business.

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But also a risk. Because the money, which is to be repaid, the company must first earn in the period. Anyone who cannot make use of a maturing loan loses a lot of trust and credibility. And the problem is that he owes a lot of money to many people.

Government/ States also issue bonds

This goes to the government/state level, by the way. Asian countries do this all the time, Since the economy is busy and the state takes a lot, European government bonds are considered safe. Because they are very much in demand, the state does not have to pay excessive interest. Countries with weak economies, such as India/Bangladesh, have a much higher default risk. 

And then have to compensate for this with higher interest rates.

Risk in bonds

There is always the possibility that the company or the state will go bankrupt before repaying the loan. Then the money or at least a part of it is gone. Anyone wishing to clear a profit – in this case, the bond interest rate – must always take a certain risk on the market. For this reason, in the case of risky bonds (see India), the interest rate or the risk compensation is also higher than the supposedly safe European Bonds.

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