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Created on 27.03.2018

What are bonds?

Bonds are usually fixed-interest securities. As an introduction to the world of bonds, we’ll explain the characteristics of a standard bond to you.

Whenever the word bond is mentioned, this usually refers to a standard or straight bond. This pays fixed interest for a set term. In addition, there are a wide variety of other types of bonds.

In contrast to shares, bonds are not just issued by companies but also by countries. The issuer raises debt capital. This means investors provide the state or company with a form of loan and receive annual interest in return. The interest rate (coupon) is fixed with standard bonds. The term of a bond is also pre-defined – i.e. the length of time investors have to wait before getting their capital back is determined in advance.

What risk do bonds present?

Bonds are traded on the stock exchange and are therefore also subject to price fluctuations. This is because the risks of the investment can change despite the interest rate being fixed. The fluctuations are usually significantly lower than on the equity market. The risk of a bond depends on the residual term, the creditworthiness of the debtor and the currency. Your return is also determined by these criteria. A higher risk for investors also means a greater return. There is also a liquidity risk where a bond is hardly ever traded as there are so few buyers. In this case, you can expect significant falls in price if you wish to sell your bond before the end of the term. With bonds there is also a risk of the interest rate changing: when a bond is issued, the level of the coupon is in line with comparable, normal market returns. If the market interest rates fall during the term of the bond, bonds become more attractive as an even higher coupon is paid out. If the interest rate increases during this period, the value of the bond decreases as the difference to the expected return is made up by the price. Bonds with a short term therefore have a lower interest rate risk than those with a long term. Although the risks are usually lower than with shares, losses can also be incurred on bonds.

What are the rights and obligations of bondholders?

Bondholders only have debt claims because they are simply lending their assets to a state or company. They are entitled to the repayment of their money at the end of the term and to payment of fixed interest.

Who are bonds suitable for?

Bonds primarily appeal to cautious investors seeking safe investment due to their greater stability and predictability. The very low interest rates at present mean that bonds have become less popular in recent years. Institutional investors in particular continue to invest relatively heavily in bonds. Pension funds, for example, generally still have high bond holdings in their portfolios despite low interest rates – this is because they represent a safe investment but also due to strict investment regulations.

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