What is a Bond?
We can say that a bond is essentially an IOU issued by governments, banks, or corporations when they borrow money from you. This IOU records details such as the amount borrowed, the interest rate, when it will be repaid, and how it will be repaid.
Yes, these are the most basic definitions of bonds. To further understand bonds and become a qualified bond investor, knowing the definition alone is not enough. Today, I have comprehensively organized the basic knowledge of bonds for everyone, hoping it will be helpful.
A tall building rises from the ground, with every brick and tile being the foundation. Only by firmly grasping the basic knowledge of bonds can one effectively expand the scope of cognition and avoid some "pits," reducing the chances of being taken advantage of.
I. What is a Bond?
(A) Definition of a Bond
Advertisement
A bond is a type of valuable security issued by various economic entities in society to raise funds. It is a debt instrument that promises to pay interest at a certain rate regularly and repay the principal upon maturity to bond investors.
1. Bonds are valuable securities. Owning a bond means possessing the rights it represents, and transferring a bond also transfers the rights it represents.
2. Bonds are a form of virtual capital. The circulation of bonds does not imply that the actual capital they represent also circulates; bonds exist independently of actual capital.
3. Bonds are an expression of debt. A person who owns a bond is a creditor, and a creditor is different from a company shareholder, being an external stakeholder of the company.(II) Bond Face Elements
1. Bond Face Value: Bonds must specify a face value, which is always an integer, and also indicate the currency.
2. Bond Maturity: A characteristic of bonds is that they must be repaid with the principal upon maturity as originally stipulated.
3. Bond Coupon Rate: Bonds pay interest at a specified rate on a regular basis. The interest rate is primarily determined through negotiation between the two parties based on regulations and the money market conditions, and is mutually adhered to.
4. Name of the Bond Issuer.
In addition, bonds also have provisions regarding early redemption, tax treatment, the possibility of default, and liquidity.
(III) Characteristics of Bonds
1. Redeemability: Bonds generally stipulate a redemption period, and the issuer must repay the principal and pay interest according to the agreed conditions.
2. Liquidity: Bonds can generally be freely transferred in the market.
3. Security: Compared to stocks, bonds usually have a fixed interest rate. They are not directly linked to the performance of the company, offer a more stable return, and carry less risk. Furthermore, in the event of a company's bankruptcy, bondholders have priority over stockholders in claiming the remaining assets of the company.4. Yield: The yield of bonds is primarily manifested in two aspects. First, investing in bonds can bring investors regular or irregular interest income. Second, investors can take advantage of fluctuations in bond prices to buy and sell bonds and earn the difference.
II. Classification of Bonds
(1) Classified by Issuing Entity
1. Government Bonds: The issuing entity of government bonds is the government. These bonds are issued by companies or financial institutions directly related to the government and are guaranteed by the government.
2. Financial Bonds: Financial bonds are a type of valuable securities issued by banks and other financial institutions as fundraising entities to raise funds for individuals. They are certificates that indicate debt and bonds.
3. Corporate Bonds: Corporate bonds are valuable securities issued by companies in accordance with legal procedures, with an agreement to repay the principal and pay interest within a certain period.
(2) Classified by Whether Interest Payments are Specified to Bondholders within a Specified Period
1. Discount Bonds: These refer to bonds that do not specify a rate on the face value. They are issued at a certain discount rate, at a price lower than the face amount. The difference between the issue price and the face amount is equivalent to the prepaid interest, and the principal and interest are repaid at maturity at face value.
2. Interest-bearing Bonds: The contract of interest-bearing bonds clearly stipulates that interest is paid to the holders regularly during the bond's life.
3. Zero-coupon Bonds: Similar to interest-bearing bonds, these bonds also specify a coupon rate, but bondholders must receive the principal and interest in one lump sum at maturity, with no interest payments during the life of the bond.(III) Categorized by fundraising method
1. Public Offering Bonds: Public offering bonds refer to bonds that are publicly issued by the issuer to the general public investors who are not specifically identified.
2. Private Placement Bonds: Private placement bonds are bonds issued to specific investors, with the target audience generally being specific institutional investors.
(IV) Categorized by credit status
1. Interest Bonds: These are bonds issued directly based on government credit or based on the government's support for repayment. In our country, interest bonds also include national and local government bonds.
2. Credit Bonds: Also known as unsecured bonds, they are issued solely on the credit of the issuer and are issued without providing any collateral or guarantor.
(V) Categorized by bond certificate form
1. Physical Bonds: These are bonds in a standard physical certificate format, typically featuring the bond's face value, interest rate, term, full name of the bond issuer, and various other bond certificate elements such as the method of principal and interest repayment.
2. Certificate Bonds: These are receipts for bondholders to purchase bonds, rather than bonds in a standard format set by the bond issuer.
3. Book-entry Bonds: These are intangible securities that complete the entire process of bond issuance, trading, and redemption through a securities account using a computer system.(VI) Categorized by whether the interest rate is fixed:
1. Fixed-rate bonds
2. Floating-rate bonds
3. Adjustable-rate bonds
(VII) Categorized by different repayment periods:
1. Long-term bonds: Those with a repayment period of over 10 years are considered long-term bonds.
2. Short-term bonds: Those with a repayment period of less than 1 year are considered short-term bonds.
3. Medium-term bonds: Those with a period of 1 year or more, but less than 10 years (including 10 years), are considered medium-term bonds.
V. Government Bonds(I) Definition and Characteristics
1. In terms of form, government bonds are a type of valuable security, possessing the general characteristics of bonds. Government bonds have a face value, and investors can earn interest by investing in government bonds.
2. In terms of function, government bonds were initially just a means for the government to cover fiscal deficits. However, under modern commodity economic conditions, government bonds have become an important means for the government to raise funds and expand public expenditure.
(II) Features
1. High safety. Among various types of bonds, government bonds have the highest credit rating and are commonly referred to as "gilt-edged bonds."
2. Strong liquidity.
3. Stable returns.
4. Tax-exempt treatment.
Prefecture-level cities and county-level governments cannot directly incur debt, so they can only indirectly borrow through urban investment companies or government financing platforms, which is called local hidden debt.
VI. National Debt(1) General Government Bonds
1. Book-entry Government Bonds: Book-entry government bonds are a type of listed securities that began to be issued in 1994. They are issued by the Ministry of Finance to various investors in society through a paperless method, with the debt recorded electronically and are tradable and transferable on the market. The issuance of book-entry government bonds is conducted through public tender, which can be categorized into three scenarios: issuance in the stock exchange market, issuance in the interbank bond market, and simultaneous issuance in both the interbank bond market and the stock exchange market.
Individual investors can purchase book-entry government bonds issued in the stock exchange market and cross-market issuance, while the issuance in the interbank bond market is primarily targeted at institutional investors such as banks and non-bank financial institutions.
Features: Can be registered and reported lost; good security; tradable on the market, with good liquidity; suitable for both long and short terms, but more suitable for the issuance of short-term government bonds; issued through the computer network of the stock exchange, which can reduce the issuance costs of securities; the price fluctuates with the market after listing, carrying certain risks.
2. Savings Government Bonds (Certificate Type): These are government bonds issued by the Ministry of Finance with a fixed coupon rate, and the debt relationship is recorded through paper media. The issuance of savings government bonds is conducted through a purchase and underwriting method.
Generally, no physical certificates are printed, but instead, a "People's Republic of China Savings Government Bond (Certificate Type) Receipt" is filled out. They are issued through some commercial banks and postal savings counters, targeting urban and rural residents and various investors, and are a type of savings government bond.
Features: Convenient to purchase, flexible in cashing out, preferential interest rates, stable returns, and risk-free.
3. Savings Government Bonds (Electronic Type): These are non-tradable Renminbi bonds with electronic debt recording, issued by the Ministry of Finance to Chinese citizens' savings funds within the territory. Savings government bonds (electronic type) are sold to individual investors through pilot commercial banks using underwriting or agency sales methods.
Features: Targeted at individual investors, not issued to institutional investors; use of real-name system, non-transferable; electronic recording of debt; safe and stable returns, with the Ministry of Finance responsible for principal and interest repayment, exempt from interest tax; interest-bearing until maturity; simplified procedures; and a variety of interest payment methods.
Differences and similarities between Savings Government Bonds (Certificate Type) and Savings Government Bonds (Electronic Type):Similarities: Both are issued at commercial bank counters, cannot be traded on the stock market, but they are the bonds with the highest credit level, guaranteed by national credit, and are exempt from interest tax.
Differences:
1. Different procedures for applying to purchase.
2. Different ways of recording debt obligations.
3. Different interest payment methods.
4. Different redemption methods upon maturity.
5. Different target audiences for issuance.
6. Different agencies handling the issuance.
Similarities between electronic savings bonds and book-entry bonds:
Similarities: Both record debt obligations through electronic accounting methods.
Differences:
1. Different target audiences for issuance.2. The mechanisms for determining the issue interest rates differ.
3. The methods of circulation or cashing out differ.
4. The predictability of cashing out gains before maturity differs.
VII. Main Methods of Bond Trading and Quoting
(I) Bond Trading
1. The methods of spot bond trading: trading at clean price, settled at full price.
2. Repurchase transactions: a form of secured lending, commonly used for government bonds.
3. Forward transactions: the period from the trade date to the settlement date is determined by the trading parties, but it shall not exceed 365 days. The transaction is conducted at clean price and settled at full price.
4. Futures trading: bond futures trading completely separates the two stages of bond trading and delivery in terms of time and space. The trading process is divided into two steps: pre-arranged trading and regular delivery.
(II) Bond Quoting Methods1. Public Quotation: This refers to the quotation made by participants to indicate their trading intentions to the market, which cannot be directly confirmed for a transaction.
2. Negotiated Quotation: This refers to the quotation made directly to the trading counterparty by participants in order to reach a transaction, which can be confirmed by the counterparty for a deal to be concluded.
3. Bilateral Quotation: This refers to the trading members approved by the People's Bank of China to carry out bilateral quotation business in the interbank bond market, who continuously quote the actual buying and selling prices of the bond species within the bond trading price spread determined by the People's Bank of China, and simultaneously quote the trading elements such as the trading quantity and settlement speed of the bond species when making spot bond buying and selling quotations.
4. Small Amount Quotation: In the trading system, convenience is also provided for small amount quotations for spot bond buying and selling, with a trading method that involves a single quotation, a specified range of trading quantities, and a specified range of counterparties for matching.
VIII. Bond Account Opening, Redemption, and Interest Payment
(I) Account Opening
1. Conclude an account opening contract. The account opening contract should include the following matters: the true name, address, age, occupation, and identity card number of the principal; the rights and obligations between the principal and the securities company, and at the same time, acknowledge the business rules and regulations of the securities exchange and the rules of the brokers' association as an effective part of the account opening contract; establish the effective period of the account opening contract, as well as the conditions and procedures for extending the contract period.
2. Open an account. After the investor and the securities company conclude the account opening contract, an account can be opened to prepare for engaging in bond trading. In China, the Shanghai Stock Exchange allows the opening of cash accounts and securities accounts.
(II) Redemption and Interest Payment
1. Bond redemption refers to the repayment of the principal, and bond interest payment refers to the payment of interest.2. Bonds typically have five redemption methods: maturity redemption, early redemption, bond substitution, installment redemption, and conversion into common stock redemption.
3. There are three main ways to pay bond interest: the coupon method (also known as the "clipping coupons method"), discount interest, and the combined principal and interest method.
IX. Bond Rating Grade Standards
Long-term bond credit ratings in the interbank bond market
According to the provisions of the "Credit Market and Interbank Bond Market Credit Rating Standards - Credit Rating Business Standards," the long-term bond credit rating symbols and their meanings in the interbank bond market are as follows:
1. AAA grade: Extremely strong ability to repay debt, virtually unaffected by adverse economic conditions, with an extremely low risk of default.
2. AA grade: Very strong ability to repay debt, not significantly affected by adverse economic conditions, with a very low risk of default.
3. A grade: Strong ability to repay debt, more susceptible to adverse economic conditions, with a lower risk of default.
4. BBB grade: Average ability to repay debt, significantly affected by adverse economic conditions, with an average risk of default.
5. BB grade: Weak ability to repay debt, greatly affected by adverse economic conditions, with a higher risk of default.6. B Grade: The ability to repay debt is significantly dependent on a favorable economic environment, with a high risk of default.
7. CCC Grade: The ability to repay debt is extremely dependent on a favorable economic environment, with an extremely high risk of default.
8. CC Grade: Offers minimal protection in the event of bankruptcy or restructuring, with little assurance of debt repayment.
9. C Grade: Incapable of repaying debt.
Except for the AAA Grade and grades below CCC (inclusive), each credit grade can be fine-tuned with the symbols " + " or " - " to indicate a slight increase or decrease from the base grade.
X. Common Bond Terminology
1. Bond Face Value
The bond face value refers to the nominal amount set at the time of bond issuance, representing the amount that the issuer has borrowed and promises to repay to the bondholders on a specific future date (such as the bond's maturity date).
2. Clean Price Trading
Clean price trading refers to the method of quoting and transacting bond spot purchases and sales at a price that does not include accrued interest, meaning that the interest accrued during the bondholding period is not included in the quoted and transaction prices. Clean price = Full price - Accrued interest.3. Full Price
The current interbank bond market and exchange bond market both operate on a clean price trading basis. Under clean price trading, when trading spot bonds, the price (clean price) quoted and traded does not include accrued interest, and at the time of settlement, the full price is used. This means that in addition to paying the transaction price according to the clean price, the buyer must also pay the accrued interest to the seller. The full price and interest are listed separately on the delivery note to facilitate tax handling for government bond transactions. The relationship between the full price, clean price, and accrued interest is as follows: Full Price = Clean Price + Accrued Interest, which is to say: Settlement Price = Transaction Price + Accrued Interest.
4. Bond Maturity
The term of a bond is the period determined at the time of issuance for the repayment of the bond's principal. The issuer of the bond is obligated to repay the principal upon maturity, and the bondholder's right to recover the principal is protected by law.
5. Remaining Term
The remaining term refers to the time until the final repayment of principal and interest of the bond, generally calculated in years. The calculation formula is as follows: Remaining Term = (Bond Maturity Date - Transaction Date) ÷ 365.
6. Coupon Rate
The coupon rate of a bond is the interest rate specified on the bond certificate, and interest is calculated and paid at this rate for the entire period before the bond matures. Assuming that the interest rates on bank deposits remain unchanged, the higher the coupon rate of the bond, the more interest the bondholder receives, and thus the higher the bond price. Conversely, the lower the coupon rate, the lower the bond price.
7. Accrued Days
The actual number of days from the interest-bearing date or the last theoretical interest payment date to the settlement date.8. Accrued Interest
Accrued interest refers to the interest income that accrues from the last interest payment date to the trade settlement date. Specifically, for zero-coupon bonds, it refers to the interest amount contained from the issue date to the delivery date; for coupon bonds, it refers to the interest amount contained from the beginning of the current interest period to the delivery date; discount bonds do not have a coupon rate, and their accrued interest amount is set to zero. The calculation formula for accrued interest is as follows (shown as the interest amount per hundred yuan of bonds): Accrued Interest Amount = Coupon Rate ÷ 365 × Accrued Interest Days × 100.
9. Yield to Maturity (YTM)
Yield to Maturity (YTM) is the rate of return at which the present value of all cash flows generated by a bond is equal to the bond's current market price. It reflects the rate of return that an investor would receive if they invested in a bond at a given price, with future monetary income received at compound interest rates.
10. Holding Period Yield
Holding Period Yield refers to the rate of return that can be achieved over a specific period from purchase to sale. The difference between the holding period yield and the yield to maturity lies in the different future values.
11. Modified Duration
Modified duration is a measure of the sensitivity of the price to changes in the rate of return. When there is a certain fluctuation in the market interest rate level, the larger the modified duration of a bond, the greater the price fluctuation (calculated as a percentage).
Finally, it is recommended that everyone should bookmark this information, and take a look and read it in their spare time.