Features of Bonds as Types of Securities

Types and Features of Securities

Meaning of Security

A security is a financial instrument or asset that represents a financial claim, ownership interest, or debt in an individual, company, government, or other organisation. Securities are bought and sold by investors in financial markets and may provide returns through interest, dividends, or an increase in value. Common examples of securities include ordinary shares, preference shares, bonds, debentures, and Treasury bonds. For example, when a person buys shares in a company, the shares represent part ownership of that company, while a bond represents money lent to the issuing government or organisation. 

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Bonds

A bond is a long-term financial security that represents a loan made by an investor to a government, company, or other eligible organisation. When an investor buys a bond, the investor is lending money to the issuer, who agrees to pay interest at an agreed rate and repay the original amount borrowed, known as the principal, at a specified future date called the maturity date. Unlike shares, a bond does not normally give the investor ownership of the issuing organisation; instead, the investor becomes a creditor. Bonds can also be bought and sold in the secondary market before their maturity date. 

Features of Bonds

1. Bonds represent debt:

A bond represents money borrowed by the issuer from investors. When an investor buys a bond, the investor is lending money to the government, company, or other organisation that issued the bond. Unlike shares, buying a bond does not normally make the investor an owner of the issuing organisation. The bondholder is therefore a creditor, while the organisation that issued the bond is the debtor.

2. Bonds have a specified maturity period:

A bond normally has a stated period for which the money is borrowed. This is known as the maturity period. At the end of this period, the issuer is expected to repay the original amount borrowed, known as the principal or face value, according to the terms of the bond. For example, a five-year bond is expected to mature five years after it is issued.

3. Bonds usually provide interest payments:

Most bonds provide investors with regular interest payments as compensation for lending their money. The interest rate may be fixed or determined according to the terms of the bond. For example, if an investor buys a ₦100,000 bond carrying an annual interest rate of 10%, the investor may receive ₦10,000 in interest per year, subject to the bond's terms.

4. The principal is normally repaid at maturity:

When a bond reaches its maturity date, the issuer normally repays the principal amount to the bondholder. For example, if a person buys a bond with a face value of ₦500,000, the ₦500,000 is normally repaid when the bond matures, subject to the terms of the issue. This repayment is separate from any interest the investor may have received during the life of the bond.

5. Bonds can be traded in the secondary market:

Some bonds can be bought and sold by investors before their maturity date through the secondary market. This means an investor who needs money before the bond matures may be able to sell the bond to another investor. However, the price at which the bond is sold may be higher or lower than the amount originally paid, depending on factors such as prevailing interest rates, demand, and the creditworthiness of the issuer.

6. Bondholders generally have priority over shareholders:

Because bondholders are creditors rather than owners, they generally have a higher claim on the assets of an issuing company than shareholders if the company is liquidated. This means that, after the claims of higher-priority creditors are settled, bondholders are generally paid before ordinary shareholders. However, repayment isn't guaranteed if the issuer doesn't have sufficient assets or defaults on its obligations.

7. Bonds have different levels of risk:

Bonds are not completely risk-free. The major risk is default risk, which is the possibility that the issuer may fail to pay interest or repay the principal as promised. Government bonds, corporate bonds and other bonds can therefore have different levels of risk depending on the issuer and the terms of the security. Generally, investors consider the financial strength and creditworthiness of the issuer before buying a bond.

Summary

• Bonds represent long-term debt.

• The holder is a creditor, not an owner.

• Usually provide interest payments.

• Have a maturity date.

• Principal is normally repaid at maturity.

• May be traded in the secondary market.