Bonds

What is a Bond?

In simple terms, a bond is an agreement between a borrower and a lender whereby the borrower finances a project by issuing a bond. Bonds, also known as treasury bills or securities, are typically issued by governments. The issuer of the bond, or “borrower,” sets the interest rate, which is then paid to the investor. When the bond matures, the investor gets their original investment back.
Unlike stocks, there is no central exchange to buy and sell bonds. The bond market is an “over-the-counter” market, which is much larger than the stock market! It’s also important to note that as a trader, you are not buying or selling a bond directly, you are simply speculating on how the bond will appreciate or depreciate over time.

How to Trade Bonds

Bond prices are affected by changing market sentiment and economic conditions, with the most influential price factors being interest rates, yields, and bond ratings. However, understanding the relationship between a bond’s price and external factors is quite complex.
Let’s look at interest rates as an example: due to inflation, the government decides to raise interest rates. When this happens, the interest rate on the bond increases, meaning that the yield, or amount returned to the investor, falls. In turn, this causes the price of the bond to fall because it is less valuable to the original investor!
If the trader had anticipated that there would be an interest rate hike, they would have sold the bond, expecting the price to fall. So in the example above, the trader would have made a profit!