Bonds

What is a bond?

Simply put, a bond is an agreement between a borrower and a lender, where the borrower finances a project by issuing a bond. Bonds, also known as treasury obligations or securities, are usually issued by governments. The bond issuer, or “borrower,” sets an interest rate, which is then paid to the investor. Upon maturity, the investor receives their principal investment back.
Unlike stocks, there is no central exchange to buy or sell bonds. The bond market is over-the-counter (OTC), which is much larger than the stock market! It’s also important to note that as a trader you don’t buy or sell the bond directly; you merely speculate on how the bond’s value will appreciate or depreciate over time.

How to trade bonds

Bond prices are influenced by changing market sentiment and economic conditions, with interest rates, yields, and bond ratings being the most influential pricing factors. However, understanding the relationship between bond price and external factors can be complex.
Take interest rates as an example: due to inflation, the government decides to raise rates. When this happens, the bond’s coupon may increase, which means yields or the amount returned to the investor may drop. This, in turn, leads to a drop in the bond’s price, because it becomes less attractive to the original investor!
If a trader anticipated a rate increase, they might sell the bond expecting its price to fall. In that scenario, the trader would earn a profit!