What is a bond in simple terms?

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Bonds have been circulating in the world for more than 200 years - a long time for experiments with different issues of the oldest securities. The first bonds were issued back in the 17th century by the state of England - under receipts-bonds, money was borrowed from the people to cover the budget deficit. That is, the same loan, but instead of a bank, people give money in exchange for interest and the subsequent redemption of securities, but without long modern contracts. In addition to the classic types of bonds that have stood the test of time and are considered the most reliable, in today's rapidly changing world, there are more and more new types of debt obligations. You just need to understand what a bond is - the forerunner of many modern financial instruments.

A bit of history

Following the example of England, the Soviet state has been issuing bonds for decades, providing bonds with additional income to solve many financial issues. In those historical times, the redemption of government securities hadcoercive nature. Moreover, the interest on payments regularly decreased, and the terms of payments were postponed by 20-30 years.

In Russia, the history of bond issues began in the 18th century with Catherine II, who pursued a successful foreign economic policy, secured loans in Holland and Italy for the protracted war with the Turks. The amount of external debt eventually reached 200 million rubles, which means about 11 billion rubles for today's money.

During the Patriotic War of 1812, a new state loan was required in the form of a short-term bond issue, but due to the forced nature of the redemption of the state loan, bonds did not become a popular security of that time.

Until the Soviet era, the state treasury lived in a long-term debt mode, issuing series of bonds, replacing old expired state treasury notes with new ones. The history of the USSR remembers bonds in the form of winning loans, with which you could buy "scarce goods." In the 1990s, issued government bonds no longer implied commodity security, being now a financial instrument in which both organizations and any individual who knew what a bond could invest.

Gold Loan

The most famous government loan in the history of the USSR was the "gold loan" of bonds of 1982. The people called these bonds, issued in huge circulation in 1982, the "Brezhnev loan", and the exact amountissued bonds were not officially reported. The denominations of the "gold loan" bonds were issued in 25, 50 and 100 rubles, with an annual income of 3%, which was considered very good money at that time. Ownership of bonds was not recorded anywhere, they were issued to the bearer, being considered practically the second currency in the country.

The bonds were drawn several times a year, and the bond whose number fell out during the draw won. Then it was possible to get winning up to 10 thousand rubles.

When the Soviet Union collapsed, debt obligations to the citizens of the country fell on the Russian Federation. The fulfillment of financial obligations in the form of payment of debts and exchange for new bonds continued until the end of 1994. The owners of the already new IOUs, which exchanged 1982 bonds for 1992 bonds, received funds on them until October 2004, then the payment period was extended until the end of 2005. The bonds were redeemed with recalculation, taking into account the denomination of 1998. It turned out that for bonds with a face value of 500, 1000 and 10,000 rubles, they paid 50 kopecks, 1 ruble and 10 rubles, respectively.

After the end of all payment terms, many holders of the "gold loan" bonds applied to the courts to resolve the issue of obtaining the funds due under the obligations. In the judiciary of our country, applicants received refusals everywhere. But the European Court of Human Rights has de alt with several appeals with final judgments bindingmake the due payments. The most persistent and patient received their money owed on government debt.

Who can issue bonds

In our country, except for the state, any legal entity, for example, a joint-stock company or a limited liability company, can issue bonds. Government bonds have the right to be placed both at the level of the Russian Federation - these are Federal Loan Bonds for Individuals - OFZ, and at the level of subjects of the Federation, for example, bonds of the Saratov Region, the Moscow Region, the city of Moscow, as well as at the level of municipalities - bonds of Novosibirsk, Tomsk.

In the "new history of bonds" until 2001, only government bonds were issued - short-term, OFZ and bonds of the subjects of the federation - Moscow, St. Petersburg, the Orenburg region.

The first corporate issuers on the Russian securities market were OAO Gazprom, later with the modern instrument Gazprombank bonds plus, and OAO NK Lukoil.

What is a bond

"Bond" means "obligation" in translation from English. What is a bond - this is a specific obligation of the debtor at a specified time to return the amount of the debt and the interest due on the debt. The issuer of the bond, the one who issued it, acts as the borrower, and the buyer of the bond is the lender. Financiers often use the slang word "bond" instead of the long word "bond", which means the same thing.

The essence of a bond is that it is a security that provides its purchaser for a certain period of income in the form of a constant percentage of its face value with a specified term of the loan relationship.

The face value of a bond is the price printed on the face of the bond and paid on the redemption date of the bond.

A bond is a long-term debt instrument, an ordinary IOU between the investor who bought it, thereby borrowing money, and the borrower-issuer who issued the bond.

The investor who bought the bonds will not be the owner of the issuer's business (as is the case with shares), he is only a creditor to the company that issued the bonds. And at the end of the agreed term for the placement of the bond, the issuing company undertakes to return the borrowed funds along with interest for the possibility of using credit money. What is a bond? It is similar to a bank deposit, when a client deposits money into an account, waits for a while, then receives his money with interest. But unlike deposits, bonds are not insured by a deposit insurance agency. The profit is almost the same both with a bond and with a deposit placement of funds.

Varieties of bonds by form

The classic form is a coupon bond - with a constant coupon, that is, a fixed percentage for payment. The company-issuer pays bondholders income in the form of coupons - the same constant payments for the entire period of placementbonds. When the bond is redeemed (redeemed by the issuer), investors receive the face value and the final coupon.

Zipless bond - no coupons are paid on it, but only the face value at the end of the loan term. The only source of profit when buying a zero-coupon bond is the difference between the purchase price and the par value written on the paper.

Recently, bonds with a variable coupon have become very popular, when the size of the coupon is unknown in advance, it is not fixed, because it changes all the time along with the cost of the bond itself, depending on the situation of the economy in the country and on world financial markets.

Eurobonds are debt securities issued on the European stock market by companies operating outside the European Union. An ordinary private investor is unable to operate with Eurobonds of Russian issuers due to difficulties in transferring capital abroad and a high “entry barrier” to this market. It is possible to make transactions with Eurobonds with a capital of at least 250,000 US dollars.

The difference in form gives some advantages to the issuer itself. Payment of income, redemption of bonds and other transactions are carried out at a lower cost for the borrower.

Bonds by maturity

• Short-term - placement of bonds for a period of 1 to 3 years.
• Mid-term - for a period of 3 to 7 years.
• Long-term - placed for a maximum maturity of 7 to 30 years. Characterized by greater price volatility when changingmarket conditions, that is, more risky.
• Permanent - from 30 years or more without a fixed repayment date.

Junk Bonds

Bonds with a high issuer default risk are often referred to as "junk" or "junk" bonds. The expression came to us from the American market - junk bonds. Junk bonds have a very high yield, but, most likely, working with such bonds is the lot of professionals who know how to assess the issuer's credit risk.

Bonds by issuer status

Corporate - issued by large enterprises, usually for a long period

Government - bonds of Russia, issued in the form of registered paperless securities by the government of the country.

Municipal - bonds of regional executive authorities.

International - issued outside the state, for example, Eurobonds issued in foreign currency.

Bonds by type of collateral

Mortgage bonds - secured by a share of property as collateral for reliability as an issuer and attracting more investors. Premises, vehicles, equipment can serve as property collateral. In the event that the issuer fails to fulfill its obligations under the bonds, investors have the right to demand the sale of the pledged property in order to return the invested funds.

Unsecured bonds - IOUs without providingany security. The reliability of unsecured bonds depends only on the financial position of the company that issued the bonds, its stability and time-tested status. Well-known large holdings issue only unsecured bonds, because their name is already a guarantee of the fulfillment of debt obligations to investors.

Differences between stocks and bonds

These are securities, financial market instruments, in which anyone can invest. Below are the significant differences between bonds and securities market shares.

1. Bonds can be issued by any commercial enterprise, as well as the state, but shares can only be issued by joint-stock companies.
2. The purchase of a bond forms the investor's attitude as a creditor of the enterprise that issued the IOU, and the purchase of a share forms the investor as the owner-shareholder of the share of the issuing enterprise, which gives him the right to participate in partial management.
3. The owner of a bond will not receive less than the original value at maturity, unlike stocks, which can significantly fall in price.
4. Coupon bond interest is predominantly fixed, while common stock dividends vary significantly as a result of the issuing enterprise's business activities, or may not be paid at all.
5. Coupon interest on bonds is paid to the investor only for a strictly specified period under the terms of the loan, while stocks generate income all the time.
6. Bond income, likefor a bond fund is always lower than for stocks, but the guarantee of getting it is much higher than for stocks.
7. Coupon interest on bonds has a priority on payments before shares. In case of unsatisfactory performance of the enterprise, a decision will be made not to pay dividends on shares, but the issue of non-payment of coupon interest on bonds is never raised.
8. In case of bankruptcy of the issuing company, first of all, debts on bond payments and other debts are paid, and only lastly - on shares. Shareholders in such cases risk not getting their money at all.

Taxation

In March 2017, following a proposal made earlier by President V. V. amendments to Chapter 23, Part Two of the Tax Code of the Russian Federation” for bonds issued in 2017-2020.

Before the adoption of the above law, the income of individuals from trading in bonds was taxed at 13% from coupon income and from the sale of bonds. The issuer who issued the papers paid the tax on the coupon, and the money came to the account already “white”. Tax on the sale of bonds was withheld by the broker at the beginning of the year or when the bondholder withdraws money from the brokerage account.

2018 Federal Loan Bonds

OFZ 2018 is characterized by an attractive interest rate forthe first coupon - 7.5% per annum, which increases every subsequent six months, amounting to 10.5% when redeemed in three years. It is government bonds that meet all the requirements of reliability and profitability that ordinary investors expect from investing their funds. Bonds for individuals in 2018 have a guaranteed high yield with the possibility of early sale and ease of purchase and redemption of bonds.