What is a bond?
A bond is a debt security, much like an IOU. The borrower (the issuer) promises in writing: I have taken this much, I will pay interest at this rate at set intervals, and I will repay it all on a given date. Governments issue bonds for roads, power or a budget gap, and companies issue them to grow their business.
When you buy a bond you are a lender, not an owner. When you buy a share you own a small piece of the company, and your share grows if profits grow. With a bond, however well the issuer does, you get only the promised interest and your principal; in return, your claim to be repaid comes ahead of the shareholders’.
Say your cousin borrows Tk 1 lakh from you to expand his shop and writes on a piece of paper: “I will pay Tk 5,000 every six months and return the Tk 1 lakh in three years.” A year later you suddenly need cash. You sell the paper to a friend; from now on the payments and the final Tk 1 lakh go to your friend. That is exactly how a bond works, except the paper is formal and traded on a market. The story is only an example.
Why it matters to an investor
- To understand regular income: you know from the start how much a bond will pay and when, provided the issuer keeps its promise.
- To recognise familiar products: treasury bonds, corporate bonds, sukuk and even sanchayapatra all rest on the same idea: lending to a government or a company.
- To understand balance in a portfolio: bond income is more predictable than share returns, which is why many people hold both.
- To see risk clearly: “fixed interest” does not mean “no risk”; you can lose money if the issuer fails to pay or if you have to sell early.
The four basic parts of a bond
- Issuer: who is borrowing, a government or a company. Your chance of being repaid rests entirely on the issuer’s ability to pay.
- Face value (par value): the amount to be repaid at maturity. For example, Bangladesh government treasury bonds are sold in units of Tk 1 lakh and multiples of that.
- Coupon: the yearly interest rate on the face value and how often it is paid. Bangladesh treasury bonds pay coupons every six months. Some bonds pay no coupon at all (zero-coupon): you buy them below face value and receive the full face value at maturity.
- Maturity: when the principal comes back. Bangladesh treasury bonds run for 2, 5, 10, 15 and 20 years; treasury bills run for less than a year.
From issue to maturity: the life of a bond
First the issuer sells the bonds to raise money; this is the primary market. In Bangladesh, Bangladesh Bank auctions treasury bonds on behalf of the government, and company bonds are issued with approval from BSEC, the securities regulator. Coupons then arrive until maturity, and on the last day the face value is repaid.
If you need the money midway, you can sell the bond to someone else; this is the secondary market. The price then need not equal the face value: it is higher or lower depending on market interest rates and confidence in the issuer. Sanchayapatra are different here: they are not traded, and if you need the money early you cash them in with the government at a lower profit.
Where the risks are in bonds
- Credit or default risk: the risk that the issuer cannot pay interest or principal on time. Credit ratings give an estimate of this risk, not a guarantee.
- Interest rate risk: when market rates rise, the price of an existing fixed-coupon bond falls. Held to maturity this stays on paper; sell early and it becomes a real loss.
- Liquidity risk: the risk of not finding a buyer at a fair price on the day you need one.
- Inflation risk: the coupon is fixed, but if prices keep rising, what that coupon can buy shrinks.
Worked example
- Say a bond with a face value of Tk 1,00,000, a 10% annual coupon paid every six months, and a 3-year term. Each six-monthly coupon = Tk 1,00,000 × 10% ÷ 2 = Tk 5,000.
- Six coupons over three years: 6 × Tk 5,000 = Tk 30,000.
- At maturity the face value of Tk 1,00,000 is repaid. Leaving tax aside, you receive Tk 1,30,000 in total.
Result: if the issuer keeps its promise and you hold to maturity, you know from day one what you will receive and when. Sell midway, though, and the price depends on the market. The rate and amounts are only an example.
Common mistakes
- Mixing up bonds and shares. With a bond you are a lender; your income does not rise when the company’s profits do.
- Thinking “fixed interest” means no risk. You can lose money if the issuer cannot pay or if you must sell early.
- Assuming you can sell at face value on any day before maturity.
- Looking only at the coupon rate and not at who the issuer is and whether it can repay.
A bond is a written loan: check four things, who is borrowing, how much they will repay, at what interest rate, and when; and remember that if you sell midway, the market sets the price.