Bonds are valuable securities issued by debtors such as governments, corporations, and banks to raise funds, following legal procedures and promising creditors to repay the principal and pay interest on a specified date.
The essence of a bond is a certificate of debt, which carries legal force. Bonds are similar to IOUs; those in need of money issue bonds, and when investors purchase these bonds, it is akin to lending money to them.
In our country, there are only three types of institutions qualified to issue bonds: governments, financial institutions like banks, and corporations.
1. Government bonds are issued by the government and backed by the national credit, offering top-tier creditworthiness, low risk, and low interest rates. Treasury bonds are a prime example of this category.
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2. Financial bonds issued by banks and other financial institutions are subject to strong regulatory oversight, also offering low risk and low interest rates.
3. Corporate bonds issued by companies may offer higher interest rates but come with higher risks as well. This is because there is a possibility that the company may go bankrupt and be unable to repay the borrowed funds.
Borrowing always carries risks, and to protect the interests of investors, bonds issued by anyone must first undergo various reviews and audits.
For instance, for companies wishing to issue bonds, the regulatory body responsible for their review is the Securities and Exchange Commission (SEC).
Before a company can issue bonds, the SEC will conduct a financial health check on the company to assess whether its operations are sound and profitable.
So, how do bonds make money?
Bonds generate income primarily through interest payments made by the issuer to the bondholders. The issuer agrees to pay a fixed rate of interest periodically, typically semi-annually, until the bond matures. At maturity, the issuer repays the principal amount to the bondholder. The income from these interest payments can be a source of regular income for investors, and the return of the principal at maturity can also provide a form of capital preservation. Additionally, if the bond is bought at a discount to its face value, there can be a capital gain when the bond is sold or matures. However, the value of bonds can fluctuate in the secondary market, which can also affect the investor's returns.Generally speaking, purchasing bonds is primarily for the interest they generate. Governments and companies issue bonds, and the public buys them. After purchasing, the public holds onto them with confidence, waiting for the maturity date. Upon maturity, they get their principal back, along with the interest they've earned.
Bonds can make money, and those who haven't bought any are envious and want to purchase them. If the people who have bought bonds are tempted by a higher offer, this can lead to trading. With trading comes a price for the bonds, and over time, there can be price differences.
Where does this difference come from? How can bond prices change? It's actually related to supply and demand.
If a particular bond is in high demand in the market and there's not enough supply, the price of the bond will rise. If the bond is not well-received and no one wants it, leading to an oversupply, the price of the bond will fall.
Since supply and demand affect bond prices, what influences the supply and demand relationship?
Let's start with the most directly related factor: changes in the market investment environment.
Take bonds as an example. Old Wang bought a bond with a 10-year maturity and a face value of 100 yuan, which pays 5 yuan in interest each year.
Coincidentally, as soon as he bought it, the central bank announced a rate cut. Following this, other banks also cut their rates, while the interest on the bond was set previously and is higher than what banks offer.
The bond, without doing anything, has 'increased in value and received a raise' due to the banks' actions.
Comparisons can be hurtful; people think that buying bonds is much more attractive than keeping money in the bank, so they all want to buy, and as a result, the price of the bond goes up.Old Wang made a decisive move, spending 100 yuan when he bought, and then selling it for 110 yuan. In addition to the interest he had previously received, he made an extra 10 yuan, which is known as capital gain. Simply put, it's about making a profit from the difference in price.
Therefore, the returns from publicly traded bonds consist of two parts: interest and capital gains.
However, buying low and selling high is certainly profitable, but it's very technical. If you make a mistake and do the opposite, you'll end up losing money. So, if you're not an experienced trader and lack professional knowledge, it's best not to meddle blindly and just stick to earning interest income.