Uncovered: Why bonds should form part of your investment portfolio
You have probably heard of bonds, but you might not understand them or the benefits of investing in them. It's worthwhile including bonds in your portfolio because they are low risk financial instruments. Here's what you need to know…
Bonds are one of the often neglected areas of personal investment portfolios.
In South Africa, the Bond Exchange of South Africa (Bondex) is responsible for the regulation and trade of bonds registered in the domestic market. The government or larger South African listed companies mainly issue these bonds.
A bond is a fixed-income security
What you need to know is that bonds fall into the classification of fixed-income securities. This is because they impose fixed financial obligations on the issuer.
Put in simpler terms, the person raising money by ‘selling’ these bonds won’t only be paying you a fixed amount of interest, but will have to repay you the amount you loaned them too!
Essentially, when you ‘buy’ a bond, you’re acting as a bank! Yes – that’s right – by purchasing a bond you’re agreeing to lend money to a government (or a company in the case of corporate bonds) in return for a certain fixed amount of interest...
To gain a basic understanding of bonds, there are a number of concepts you need to familiarise yourself with explains Gareth Stokes in Fear, Greed and the Stock Market
Your guide to understanding bond terminology
is the interest rate that you (the investor) will receive for the duration of the bond issue. This is also known as the interest income or nominal yield.
is the number of years before a bond expires. Most bonds have a single maturity date and are known as term bonds.
The principal value
is the value of the original obligation (also called the par value
). In other words, this is the amount you would have paid if you took up the bond at the date of issue. It isn’t the same as the current market price of the bond.
There are various types of ownership
for bonds, either bearer bonds or registered bonds. The only difference here is that with the bearer bond the issuer keeps no record of ownership.
To sum up: A bond is a form of loan that you make to the bond issuer (usually the government or large company). You’ll pay a principal value (if you’re buying a new bond issue) or a market price (if you’re buying a bond on the open market). In return, you’ll get a coupon interest rate which will be paid to you twice annually until the bond matures.