What Is a Bond and What Are Its Main Characteristics?

To define bond characteristics, we need to clarify how it works. Some beginners mistakenly consider them stocks. However, bonds are different, as they can be issued not only by corporations but also by a government with the aim of raising funds. When someone purchases a bond, he or she provides the issuer with a loan. On the other hand, a borrower (a company or government) accepts the obligation to pay out the face value of the loan on a pre-defined date. What’s more, as an investor, you can benefit from periodically paid interest rates until that date.

So, what is a bond? Unlike stocks, they do not provide investors with an ownership share. You cannot own a part of the governmental infrastructure. It means that it does not matter if the enterprise shows some rapid growth or decrease in revenue. The only thing that matters is if it is going to have enough resources to pay when Day X arrives.

Major Characteristics to Define Bond

When investing in bonds, traders have several potential benefits when creating a diversified portfolio. First of all, they offset volatility that often comes as the dominating force when investing in stocks. Secondly, it ensures a quite stable income stream over a specific period of time.

Before we discuss major bind types, we need to stop at some of their major characteristics. They will make it possible for future investors to evaluate them and decide if they are a good pick for the portfolio:

1. Face Value. It is the sum you can get by the expiring date. In other words, it is the bond value when it eventually reaches its maturity.
2. Maturity. It is the date when the issuer will pay out the debt to the lender in the face of the investor.
3. Coupon Rate. It is the level of interest rate that you will receive as an investor from the issuer. As a rule, the coupon rate depends on the bond face value.  
4. Coupon Date. It is the date when you are going to receive interest rate payments. The time frames can vary from one issuer to another. However, the most common intervals involve semiannual payments.
5. Issue Price. It is the price at which the government and enterprises issue their bonds.

The next stage to define bond types is to check their major categories.

Common Bond Categories

All bonds are divided into four major categories depending on the issuer and some other crucial parameters:

• Corporate bonds – are generally issued by companies, which do not want to borrow from banks or some other financial organizations. With issued bonds, they benefit from lower interest rates and more favorable lending conditions.
• Municipal bonds – issued by municipalities, they offer tax-free coupon income, which means additional benefits for investors.  
• Government bonds – issued by the government and also known as notes, refer to a so-called sovereign debt. The maturity period may vary from 1 to 10 years.
• Agency bonds – these bonds generally refer to government-affiliated enterprises and organizations.

Now, let’s have a look at some other types of bonds from the investors’ angle.

Holding vs. Trading Bonds

A holding bond is an asset that you buy and keep for a fixed period of time while collecting interest rates and waiting for it to reach maturity when the issuer will eventually repay the face value. In other words, you just buy a bond and hold it until the repayment day.

A trading bond is a bit different type of asset that can be purchased or sold in the secondary market. When the government or an enterprise issues the bond, the initial price may change and fluctuate the same way as the stock price. So, you may have a chance to sell it and generate instant revenue. However, you should note that price fluctuation will not change the interest rate you get from the issuer as well as the face value you will receive in the end.

The Bottom Line

What is a bond and how to trade it? The bond market may seem a bit complicated at first. However, you only need to learn some baseline criteria and characteristics of the asset. What’s more, an in-depth analysis of the issuer may also help. After you are able to master several baseline approaches as well as bond types, you may become an investor.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.