Bonds stand for a widespread type of debt securities expressing the issuer's liability to the creditor. The bond issuer (government, bank, company) is the debtor; the bond holder (investor) is the creditor. Usually, the issuer issues bonds in order to acquire long-term funds. The bond owner is entitled to receive the due amount in its nominal value and to receive the yield (coupon payments) from the bond as of certain date. On the contrary, the bond issuer is obliged to repay the nominal value of the bond and relevant interest. The nominal value is repaied either on a lump sum basis as of given date, or in several instalments. Contrary to traditional loans, bonds can be traded in secondary securities markets (such as PSE or RM-system).
Classification of bonds by the issuer depends on the particular entity of the issuer and circumstances of the issue. This is also associated with determining the risk, or rating of the issuer.
The issuer of government (sovereign) bonds is the government; in the case of the Czech Republic it is the Ministry of Finance of the CR. The Czech National Bank arranges for the issue and payment of interest. Generally, government bonds tend to bear lower risk. The government usually uses the borrowed money to solve discrepancies between income and expenditures in the state budget.
Municipalities and towns are issuers of municipal bonds, frequently using the money to finance their development needs.
Corporate bonds are issued by corporations or companies in need of capital for its business. The risk associated with corporate bonds varies, while the risk level is reflected by the interest rate.
Issuers of bank bonds are financial institutions. For example, these can be bills issued by CNB, long-term bank bonds, mortgage bonds, or deposit certificates.
Treasury bills are short-term bonds issued by the government or public authorities. This type of bonds serves for short-term cover of temporarily lacking funds. Treasury bills are the least risky bonds, which is also reflected in the low interest rate applied.
From the perspective of maturity, we can distinguish among short-term, medium-term and long-term bonds.
For short-term bonds, maturity is up to one year, and they mostly concern treasury bills, commercial notes or deposit certificates. Maturity of medium-term bonds varies between 1 and 5 or more years, while maturity of long-term bonds may exceed even 10 years.
The categories depend on the interest payment method.
Fixed yield bonds
The coupon is agreed upon issuance and remains unchanged throughout the bond term. The advantage is that the credit can easily calculate the yield to maturity. On the contrary, no response to economic fluctuations is their disadvantage.
Variable yield bonds
The coupon depends on a market reference interest rate, often an inter-bank rate, such as PRIBOR, LIBOR or EURIBOR. This bond type is particularly popular among investors expecting future growth of rates.
Zero yield bonds
With these bonds, creditors are not paid coupons. The creditor realizes a gain by purchasing the security at a discount, i.e. a price below the nominal value.
Yield generated by index bonds is dependent on development of the underlying indices, such as gold prices, oil or other commodities.
- Hybrid bond - includes a coupon rate combining fixed and variable parts
- Bond secured by issuer's assets - secured by real property
- Payment-in-kind bond - coupon payments are made in a certain commodity
- Redeemable bond - under certain condition, the bond can be repaid or called early
- Extended bond - allows for prolonging the maturity term
- Perpetual bonds - bond without a given maturity date
- Convertible bond - the bond owner can exchange it for a defined number of the issuer's shares in the course of the maturity term
- Option bond - includes an option note (warrant) - the owner is entitled to buy certain securities under given conditions
- Bonds with deferred payment - these bonds are free of any coupon in the first years
Bonds issued in documentary form meets the following requisites:
- Information about the issuer,
- Name of the bond containing the word "bond", or identification of a special bond type pursuant to Sec. 14, 18, 20, 21a, if any, as well as ISIN, if any,
- Nominal value,
- Information about approved issuance terms and conditions,
- Bond yield or its calculation method,
- Date of the issue,
- Method and place of payment of the bond's nominal value and yield,
- Form of the bond,
- Representation of the issuer on his commitment to repay the due amount in a manner and at a place stated in the terms and conditions of issue,
- Maturity dates of the bond and yield, unless the yield is given as difference between the bond's nominal value and its lower issue price,
- Number identifying the bond,
- For registered bonds, the name and surname, business name or name of the first owner,
- Signature or imprint of the signature of persons authorized to act on behalf of the issuer as of the issue date, or signature or imprint of the signature of the issuer.
On average, bonds tend to suffer less from fluctuating market prices, which brings less fluctuating yields, and thus they bear less risk among investments assets
Regular pay outs and certain yield with fixed coupon bonds or easier estimate of future yields with variable coupon bonds
Possible sale of bonds before maturity at an exchange
Bonds can be purchases at exchange or banks
Traditional disadvantages usually include higher minimum investment; the nominal value of bonds reaches dozens or even hundreds of thousands crowns
Compared against stocks, bonds achieve smaller liquidity on the exchange
Compared against stocks, bonds general smaller gains in the long run
Certain bond types can be unsuitable at times of economic growth