Bonds can be issued by private companies or by States and are low risk investments to have in a well diversified portfolio.
What are bonds, differences between bonds and stocks
The distinction between bonds and stocks is one of the fundamental divisions of finance. The distinction between risk capital (shares) and debt (bonds) is fundamental to understand what kind of investment a saver is making.
When you buy a share in a company, you become a shareholder of the company and therefore participate in risk capital: you are subjected to greater uncertainty in exchange for probably higher returns.
Instead, when you buy a bond, you buy part of the debt of a company or a State, debt represented by a security, and you only become a creditor. In theory, therefore, unless a bankruptcy of the company or of the State in question, the creditor must recover the subscribed capital at a pre-established deadline plus the interest provided for in the contract.
Fundamental characteristics of the bonds
The bonds have:
- a nominal value which corresponds to the capital that is subscribed in the initial phase and compensated on expiry
- a coupon that corresponds to the periodic interest that the issuer pays periodically to its bondholders
- a deadline indicating the date by which the initial capital is returned to the bondholder
- an issuer, i.e. the company or state that issued the bonds
Senior and subordinated bonds
In the event of issuer default, there are various compensation hierarchies: the category of bondholders is divided between who owns a senior bond, who is paid first, and who owns a subordinated bond, who is compensated in the alternative.
Subordinated bonds have become popular (in the negative sense) in recent years due to some credit institution crises that have caused the failure to compensate the bonds held by small savers. Subordinated bank bonds are classified according to the following increasing order of subordination (and therefore of default risk): Lower Tier 2 and Tier 3, Upper Tier 2, Tier 1.
Who issues the bonds?
Depending on the issuer, bonds can be divided into three main categories:
- government bonds: they are the debt securities of a nation that is financed in exchange for an interest (for example, Italian BOTs and BTPs, Us treasury bonds, Spanish bonos, German bund…)
- corporate bonds: in this case the bond is issued by a company that is indebted to the market, almost always to access this market you need to be a bank or a large multinational company capable of managing and guaranteeing this type of issue
- supranational bonds: these are bonds issued by international organizations such as the European Investment Bank or the World Bank