One type of passive income is investing in bonds. Bonds are debt securities. They are issued by an issuer – a company (or government) that needs money.
The investor, who appears in the conditional format of the lender, buys bonds and thus lends his money to this company, hoping to receive a certain income.
Characteristics of bonds:
- Denomination This is the price at which the bond will be redeemed by the issuer at the end of the term.
- Market price. The range of market price fluctuations is 95-105% in relation to par. It depends on the following factors: the level of supply and demand, interest rates.
- Maturity date. This is the date of payment of the par value of the bond, which is indicated by the issuer upon issue. Sometimes an offer date is set when the issuer can pay the par before the maturity date.
- Coupon. This is income-generating cash. The coupon rate is the bond's annual yield. For example, the issuer sets a 10% coupon to the face value of a $ 50 bond. In this case, the investor will receive an income from investing in one bond in the amount of $ 5.
Types of bonds
- state – they are released to cover the budget deficit;
- municipal – they are issued by local governments, for example, to finance various projects;
- corporate – they are issued by commercial enterprises to finance their activities.
By the form of payment of income:
- coupon (interest) bonds – on them you receive interest on the par value.
- zero coupon (discount) bonds – when purchased, they are below par, but are redeemed at par.
- short-term (maturity less than a year);
- medium-term (from 1 to 5 years);
- long-term (more than 5 years).
By way of treatment:
- free float bonds;
- restricted bonds.
- secured – the most reliable. The safety of investments can be secured by a pledge (real estate, company equipment or other securities), a guarantee of another company and a bank, state or municipal guarantee;
- unsecured – less reliable. If the company goes bankrupt, payments depend only on the solvency of the issuer.
Pros and cons of bonds
- risks when buying bonds are less than when investing in stocks or other securities;
- income on bonds is on average higher than on a bank deposit;
- interest payment guarantee. The issuer is obliged to pay income on bonds, the amount and frequency of payments is determined when the bond is issued;
- income from certain types of bonds is tax-free. If you have invested money in bonds through an individual investment account (IIA), you can still receive a tax deduction.
- the yield on bonds is not high than the riskier instruments of the financial market;
- investments in bonds do not participate in the deposit insurance system.
As with all types of investment, investing in bonds has its own risks. To minimize all risks, you should adhere to the following recommendations:
- It is better to opt for bonds with an average yield from reliable issuers, the higher the yield of bonds, the higher the risks. Government bonds are considered the most reliable; beginners should start with them.
- If there is instability in the market, you should not buy long-term bonds with a maturity of 3 years or more.
- When trading bonds, you don't need to make hasty decisions.