If you have invested, or you are considering to invest in future offers, how well do you understand bonds?
The Federal government wants to borrow more to finance the huge government deficits, and they want to use up all possible avenues in doing so.
But before you invest, how well do you understand what you are about to do. And what will you stand to gain or lose if you invest in it.
1.What are Bonds?
Bonds are IOUs (I owe you) issued by a borrower to a creditor that specify the payment of a borrower to a creditor.
It is a piece of paper or these days an electronic document.
Bonds are created when a creditor makes a payment to a borrower who in turn receives a paper or a certificate or an electronic document as an evidence.
That paper is called bonds.
Have you ever tried to borrow from your friends before?
If you have, think about borrowing from them, maybe you want to buy a land that costs a million naira. But you only have five hundred thousand naira.
You meet five of your friends and ask them to lend you the remaining five hundred thousand. Let’s say that each of them gave you one hundred thousand naira and you signed a paper acknowledging that you received the sum of five hundred thousand naira from the five of them.
That paper you signed is called bond.
The only difference is that you are not allowed to call what happens between you and your friends’ bonds. With your friends, you don’t even sign papers. They are only assured that since you are their friends, you will pay back.
And when you don’t pay back, your friends will come to your house at night and cause chaos until all your neighbours are awake and find you holding one another on the neck.
Bonds and stocks are both securities.
But the major difference between them is that when you buy the stocks of a company, you are buying an ownership (equity) into the company. While with bonds, the company owes you. A debt which they are obligated to pay back in the future.
When you own stocks, you are part of the owners of the company. You can go around telling your friends that you own that company or this company. You can even question the managers of the company and use it to pump your ego.
But with bonds, you do not own the company. They are only owing you.
Therefore, a bond is a form of a loan. The holder of the bond is the lender, the issuer of the bond is the borrower.
2. Why are bonds important to you as an investor?
Bonds can serve as both medium and long term savings.
With the federal government savings bonds, you can save towards a particular need.
Let’s say you want to quit your boring job in the next five years to start your own thing, whatever it is. You can use bonds to save towards that goal.
You can also save for a long-term need like retirement.
Bonds can also serve as a source of steady income streams for coupons bonds (i.e bonds that pay interests).
Most bonds provide the investor with fixed income. It can be quarterly, semi-annually or annually, the bond issuer provides an interest payment which can be spent or reinvested.
Investment in bonds can help you diversify your portfolio in an effort to reduce risks or negative returns on your portfolio.
3. Who Are the borrowers in the Bond Market?
- The Federal Government. When the federal government goes to the capital market (A market for long-term funds) to raise bonds, it is known as Treasury bonds.
- The State and Local Government. When states and local governments borrow from the capital market, it is known as municipal bonds.
- When companies borrow, it known as corporate bonds
Bonds are used by federal, state, local government and companies to raise money and finance a variety of project. They are one of many instruments that have helped build nations.
In the next post, we will get to understand the different types of bonds and how you can benefit from them.