Different types of bonds

The purpose here is not to give a complete lecture on what is bond. It serves to achieve a quick general understanding of what bond is for those who have not much knowledge on financial products. It hopes that the basic facts will be useful to someone who is considering to invest, yet have no idea what financial products to consider.

What is a bond?

A bond is a contract or promise by an entity to return a sum of money after a certain period of time, over the course of which interest is paid.

What are the meaning of terminology related to bond?

• Bond issuer - Entity
• Bond holder - Investor
• Tenture - Fixed period by which the money has to be repaid
• Par value/ face value - When bond matures, the investor is repaid the principal sum lent
• Coupons - Steady stream of interest payouts over the life of the loan. Payout can be annually or half-yearly

How to analyse bonds return?

One have to consider the market price of the bonds and the coupons received, in order to determine the absolute return.

How to compare return of different bonds?

Use bond yield to compare return of different bonds. Take coupon divide by market value and this will give you bond yield (coupon / market value = bond yield)


What are the risks?

• Credit risk of bond issuer: The entity defaults on the regular payout of coupon, fails to return principal sum (worst scenario) or unable to liquidate the bond where market see little/no demand.
• Inflation risk: In an inflationary environment, bond holders face the risk of having their real returns eroded by inflation or get negative return when inflation rate is higher than coupon rate.

What are the different types of bonds?

• Notes: Short-term bonds with maturity of less than a year. Returns are lower than longer-term bonds' as exposure to inflation risk is shorter.
• Long-term bonds: Bonds with maturity of between 10 and 30 years.
• Convertible bonds: Bonds with the option to be converted into stocks.
• Junk bonds: Bonds with high default risk, rated BB or lower. Because of their higher risks, they usually have higher returns to attract investors.
• Inflation-linked bonds: Bonds that have year-end payouts, in addition to the coupon, to compensate for inflation.
• Sovereign bonds: Bonds issued by goverments.
• Zero-coupon bonds: Bonds that do not give out coupon payments. Instead, they are sold at a discount to the par value upfront.