Some investors hold bonds to earn a steady income. Other investors try to make money by trading.
So, what are bonds?
A bond is a debt instrument issued for a predetermined period of time with the purpose of raising capital by borrowing. A bond generally involves a promise to repay the principal and interest on specified dates. This kind of debt instrument may also be called as bills or notes and these names are used interchangeably in the market.
Common features of bonds
- Issuer: This is the party that borrows the money. Bonds are commonly classified by the nature of their issuer, for example, corporate bonds (issued by companies or their subsidiaries), government bonds (such as Exchange Fund Notes issued by the Hong Kong Monetary Authority), and bonds issued by supranational organizations (like the World Bank).
- Principal: This is also called the par value or face value. It is the amount repaid to the bondholder when the bond matures.
- Coupon rate: This is the rate at which the issuer pays interest on the principal to the bondholder each year. Interest payments are normally made at regular intervals, e.g. annually, semi-annually, quarterly. The coupon rate can be fixed, where it does not change over the term of the bond. It can be floating, where it is reset periodically according to a predetermined benchmark, such as HIBOR plus a spread. The coupon rate can even be zero. A zero-coupon bond is usually sold at a price below its principal. The bondholder's return is then the difference between the purchase price and the principal repaid on maturity.
- Term: This is the life of the bond, i.e. the period (usually a number of years) over which the issuer has promised to meet its obligations under the bond. Some bonds can be "perpetual" in the sense that they do not have a fixed maturity date.
- Guarantor: Some bonds are guaranteed by a third party called a guarantor. If the issuer defaults, the guarantor agrees to repay the principal and/or interest to the bondholder.
The Hong Kong debt market
To know more about the development of bond market in Hong Kong, you can click here to read the article prepared by the Hong Kong Monetary Authority (HKMA) on the subject.