There are various forms of investment in capital markets and money markets.
In these markets the parties with surplus cash (investors) lend money to the parties with deficit or not enough cash. (cooperation’s and governments)
Bond issuance is one way of acquiring enough cash/capital. Here, investors and companies or the government come up with well-defined agreements involving huge amounts of money, say millions and billions.
Wait! Wait! let’s pause for a moment. Let’s start from the basics.
what are bonds
Bonds are tools of debt. what do I mean? By this I mean that they are loans through which government or companies raise debt capital to fund their operations or their planned capital projects.
Just like a normal loan a bond has periodic interest payments and a maturity date.
The investor benefits from periodic interest rate payments. A bond certificate is also given to the investor.
The party that receives the funds from the investor is the issuer of the bond. Bonds are normally long-term and therefore they are traded in capital markets and not in money markets where short-term tools are traded.
Types of bonds
These kind of bonds are issued by corporations/companies. Companies raise this bonds to raise capital for their projects.
This type of bond normally has higher interest rates than treasury bonds. The interest rates of this bond are taxable.
It’s only companies listed in the stock exchange markets which are able to benefit from this bond.
Investment banks act as intermediaries between investors and issuers to make this capital readily available to companies.
Treasury bonds are issued by the government. They are normally issued when there is a lot of money in circulation in the economy.
The citizens then obtain these bonds and the level of money in circulation is regulated. It’s also a tool used to control inflation rates. The periods differ from country to country.
In Kenya treasury bonds are normally long term but some have short periods of even up to 90 days. Bonds are normally low risk investments. This is because they are backed up by the government which almost never defaults.
How bonds work.
let’s do some simple calculations.
Let’s say you purchase a 10 year treasury bond of Sh10 million paying 3%interest with periodic payments of 6 months.
The issuer (government) will pay you Sh 300,000 every six months and repay the principal amount at the end of 10 years.
You will then be issued with a bond certificate stating the terms of agreement. You can then sue the issuer incase of default.
Bonds are also evaluated. This is done through bond rating.
Bond rating is where the financial capability of the institution issuing the bond is measured in order to check how risky the bond is.
According to one common bond rating agency Moody’s and Fitch. The higher the bond rating the safer the bond is.
High rating bonds offer low interest rates compared to the lowly rated bonds. Lowly rated bonds have higher interest rates due to the additional risk.