Fixed-income securities: How bonds work

Julie Brownlee, Fsp Invest, 11 Mar. 2014

Tags: bonds, what is a bond, yield-x, fixed-income, fixed-income securities, south african bond market, bond terminology, investing, investors, maturity, principal value, par value, coupon, interest income, nominal yield

When you invest, it’s all too easy to focus on buying shares for your portfolio. But you can also invest in bonds. With bonds you know what you’re getting in terms of return. You can’t say the same for shares. Because of this, bonds carry less risk than shares. Bonds should form part of a balanced, diversified portfolio. Read on to find out how bonds work…

The South African bond market

Many investors are quick to buy shares, but often neglect buying bonds, Gareth Stokes in Fear, Greed and the Stock Market explains. And that’s despite the bond market’s value being greater than the stock market’s value.

In South Africa, the bond market is part of the JSE. It’s called Yield-X. The Yield-X regulates and is responsible for the trade of bonds registered in SA.

The South African government and large South African listed companies mainly issue bonds on Yield-X.

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What you need to know about bonds

Bonds are fixed-income securities. This is because bonds impose fixed financial obligations on the issuer. For example, the government.

When you buy bonds, you’re lending money. So if you buy a government bond, you’re lending money to the government. And in return for that loan, the government or company will pay you a fixed amount of interest.

The need-to-know bond terminology

To understand how bonds work, you need to get to grips with the terms used with them…

Coupon (or interest income or nominal yield)
This is the interest rate you’ll receive for the duration of the bond issues.

This is the number of years before a bond expires. In most cases, bonds have a single maturity date. For this reason, they’re known as term bonds.

Principal value (or par value)
This is the value of the original obligation. This is the amount you would have paid for the bond on the date of issue. It’s not the same as the current market price of the bond.

So there you have it, how bonds work.

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