In this series of posts, we will cover bonds and debt securities from the ground up. We’ll discuss the history, the basic mechanics of bonds, and go into detail on specific types of assets. We hope to leave you with a better understanding of how bonds and fixed income work and how you can leverage these assets in your own cash management and investment strategy.
Part 1 – Introduction
Equity vs Debt
Most people are well aware of the stock (equities) market. It’s a frequent topic in even non-financial news and anyone with a 401k plan has owned stock themselves.
Bonds (or Fixed Income) by comparison, are much less talked about and less well understood, even though the bond market is far larger than the stock market.
When you own stock, you are part owner of a company. As the company does well, the stock price increases you participate in that appreciation. Of course, the opposite can happen as well. When the company does poorly, the share price decreases and you lose money. In stocks, you can win big and you can lose big.
When you own a bond, you own the debt of a company or entity. You are entitled to receive a fixed amount of money in the form of periodic interest payments for a specified period of time, after which the original amount is repaid. It doesn’t matter how well or poorly the company does – the amount you are paid is the same. Unless the company goes bankrupt, that is!
To use another analogy, consider the situation of taking a mortgage to buy a home. The homeowner can be said to own “stock” in the house. Because they own it, if the price of the house doubles, they have made a profit. The bank that has issued the mortgage, on the other hand, is the bondholder in this situation. They collect interest payments from the homeowner, making a modest profit until the mortgage is repaid. It doesn’t matter to the bank if the home’s value goes up or down. They only make money from the interest payments which are fixed at the time the mortgage is created.
Though the global market for equities is massive, the global market for bonds is actually over 30% bigger, at over $102 TRILLION!
As the charts below demonstrate, the majority of bonds are issued in the US and other developed markets such as Japan, the EU and the UK, – though in recent years there has been a large growth in emerging market bonds.
In the United States the bond market is over $45 Trillion, and consists primarily of bonds issued by the Federal, State & Local governments, corporate bonds, and fixed-income securities backed by mortgages & other assets.
In the upcoming posts in this series, we’ll dive into the history, mechanics and characteristics of bonds and the bond market. By the end, you should have a good understanding of how bonds work and how you can incorporate them into your corporate cash management and investment strategy. Stay tuned!