Bonds are fixed-income instruments in which the issuer pays interest to the holder of the bond and repays the principal at the maturity date. Interest is usually paid annually, semiannually, or monthly. A bond can be resold in the secondary market before it matures at a price larger than face value. Bonds are usually issued by governments, corporations, or central banks.
Bonds are countercyclical instruments. It means the highest demand is when the economy is slowing, heading to recession or depressing. They are perceived as safe investments and investors are seeking protection in times of uncertainties. The bond yield is decreasing when the price of the bond is increasing, also the longer the maturity usually higher yields. Investors are seeking a higher return for longer tied debt. In times of expansion, stocks provide higher returns and bonds are less attractive.
The safest debt instruments are Treasury bills, notes or bonds which are backed by the US government. Treasury bills are issued for a period less up to one year. Treasury notes could mature up to ten years, while Treasury bonds are issued for up to 30 years.
Bonds are often held for diversification of portfolio which can in combination with stocks offer a higher return and lower risk. Treasury inflation-protection securities are bonds which value is adjusted due to inflation.
10-year Treasury notes yields are closely watched by policymakers as they indicate the prospects of economic growth. When yields are falling it means market believe the economy is heading to a recession. Demand for longer-term bonds is rising, rising their value and dragging yields down.
Treasury bonds have a huge impact on the economy. Primarily, they provide spending of the US government which cannot be afforded with taxes. The US biggest creditors are China, Japan and oil-exporting countries. Bonds also affect mortgage interest rates. Lower interest on bonds also means the lower interest on mortgages enabling peephole easier to by new homes.
Bonds have many advantages over stocks and other instruments. Lower volatility fixed guaranteed interest and bondholders enjoy legal protection. However, bonds are prone to many risks like prepayment risks, credit risk, liquidity risk., event risk etc.
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