By reading the article “What are bonds?” Published in Adaas Capital, you will be introduced to the concept of Bond in the economy in general. This level of familiarity can be enough when you need educational information about this topic.
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What are Bonds?
In the simplest sense, a bond is a document that pays the holder a fixed amount for a fixed period in accordance with the law. In fact, bonds are a form of government debt.
The investor on the bonds is the lender (lender) and the issuer is the borrower. The issuer borrows a bond from investors to receive a fixed interest rate over a period of time, and at the end of the term and maturity, the issuer repays the principal amount of the loan.
For example, suppose each bond is $1,000 or a multiple of that, which is essentially the face value of the bonds. Some of these bonds are paid interest at the nominal value or principal of the capital twice a year, which is called interest (quota return) or coupons on these bonds, and for this reason, other bonds are called fixed-income bonds.
Interest rates on bonds
Long-term bonds have a higher interest rate as a return on investment because higher interest rates compensate for the risk that interest rates will increase before the maturity of the bonds, which is called interest rate risk.
The quality and creditworthiness of a bond depend on the ability and willingness to pay the principal and the interest rate of the issuer, whether it has strong backing or not. The stronger the backer or issuer of these securities, the lower the interest rate.
In other words, we can say that the relationship between the interest rate of these bonds and their validity is in conflict. A higher interest rate is actually a reward for the investment that may not be able to reach its capital at maturity, which is called credit risk.
All kinds of the BOND issuer
Bond issuers are generally divided into three categories:
- Treasury bonds are issued by the federal government.
- Municipal bonds are issued by local and state governments.
- Corporate bonds are issued by businesses and corporations.
What are U.S. Treasury Bonds?
These are bonds issued by the United States government. Join Adas Investment Magazine as we explore different types of Treasury bonds!
Types of U.S. Treasury Bonds
- Treasury Bills
Due to their short maturity, these bonds are called short-term Treasury bonds. These bonds are a US government debt document that matures in less than a year.
- Medium Term Treasury Bonds | Treasury Notes
Due to the medium-term maturity of these documents, they are called medium-term treasury bonds. The maturity of these bonds is between 2 to 10 years from their issuance.
- Long-Term Treasury Bonds | Treasury Bond
Due to the long maturity of these documents, they are called medium-term treasury bonds. The maturity of these bonds is between 10 and 30 years. That is why they are called long bonds.
- Treasury Inflation-Protected Securities
These bonds are a type of treasury bond that was introduced to the market in 1997. Their characteristic is that the value of these bonds is protected against rising inflation. In fact, the interest paid on these documents is adjusted to cover inflation and price increases at the general level. The basis for increasing this interest rate is the consumer price index or cpi.
The yield on Treasury bills is lower than the interest rates on other types of bonds because it poses no financial risk or credit risk. Therefore, when people are not sure about the economic situation and its prospects, they seek to buy these bonds.
The main purpose of the US issuance of these bonds is to finance the budget deficit. The relationship between the value of these bonds and the bank interest rate and the discount rate is an inverse relationship because when the discount rate is higher in an economy, the price of these bonds decreases.
The interest rate on these bonds is a function of the purchase price, face value, and time remaining until maturity. Because the closer we get to the end of these bonds or their maturity, the higher their price and the lower their return. In other words, the relationship between the yield of these bonds and their price is an inverse relationship.
Federal Bonds and Monetary Policy
With these bonds, the Fed can implement its monetary policy in some way. Thus, the central bank during its contractionary policies, which uses this policy to curb inflation and raises interest rates, comes and sells bonds, which reduces liquidity in society And controls inflation.
Conversely, in expansionary policies to get out of the recession, central banks buy bonds with banks, which expands the money supply and helps increase banks’ lending capacity.
10 year US Treasury Bills
Since the collection of 30-year Treasury bonds in October 2001, 10-year Treasury bonds have been used as a basis or tool for long-term interest rates and are now the most important indicator of inflation expectations. With lower interest rates and strong economic data, we can expect bond prices to rise.
The end words
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In the simplest sense, a bond is a document that pays the holder a fixed amount for a fixed period in accordance with the law.
– Treasury bonds issued by the federal government.
– Municipal bonds are issued by local and state governments.
– Corporate bonds are issued by businesses and corporations.