What are bonds? Types of bonds and how to invest

If you are interested in investing in the Stock Market, it is important that you know the bonds and what advantages they offer you. As an investor, you should seek a well-diversified investment portfolio, where you achieve a balance between stocks or variable-income investments and bonds or fixed-income investments.

This way you can ride out market volatility while capturing growth along the way.

Learn in this article everything you need to know about this fixed income investment alternative, which are bonds, their classification and types. In this way you can begin to consider this investment in the stock market as one more option that the market offers you apart from stocks.

Bonds: What are they?

These financial instruments are titles that represent a debt that the issuing entity has with the natural or legal persons that acquire them.

The simplest illustration of how a bond works is an investor making a loan to a bond issuer, in exchange for a return of the investor’s principal plus interest. The investor granting the loan is a bondholder. Companies, corporations and governments issue bonds to finance various activities and projects.

When you buy a bond you become a creditor of the issuer. This is the key distinction between stocks and bonds. When you own a share you are a partial owner of the company.

As the owner, you can participate in the profits of the company through dividends and the appreciation of its share price.

If you are a bondholder, you do not participate in the profits of a company. The interest and principal you receive don’t change no matter how profitable the company is, so bondholders never have to wonder how much they’ll be paid.

Unlike dividends, which companies can choose not to pay, payments to bondholders are guaranteed and take precedence in the event of company bankruptcy.

Why invest in bonds?

Bonds tend to offer reliable cash flow, making them a good investment choice.

A well-diversified bond portfolio can provide predictable returns, with less volatility than stocks and better returns than money market funds.

Even when interest rates are low, bond investment options, such as high-yield debt or emerging market bonds, can meet your need for income as an investor, albeit at substantially higher risk.

Bond Classification

Bonds are classified into two large groups:

Private debt bonds:

These are issued by private sector entities, in which the national government does not have a dominant or majority position. The placement of these bonds allows issuers to obtain long-term financing at competitive interest rates and eventually in large amounts. In addition, they can make partial amortizations of the debt or the total payment at maturity.

Public debt bond:

These are issued by public sector entities or those in which the government’s participation exceeds 51%.

There are internal and external public debt bonds through which the national government obtains resources to finance its activities.

Types of bonuses:

Depending on the type of bonds, at the time of bond issuance, the following is set:

  • The nominal value, which corresponds to the amount that will be repaid at the end of the respective term;
  • The term of the loan and, therefore, the maturity of the bonds;
  • The existence and frequency of interest payments;
  • The applicable interest rate, which can be fixed or variable.

The different types of bonds that can be acquired are:

Ordinary Bonds:

These have the general characteristics of bonds, in which the issue establishes the assets that guarantee compliance with the obligations, if necessary, and where the issuer’s assets support the issue.

Bonds convertible into shares:

These are the ones that the issuer redeems and delivers to the investor shares issued by the issuer of the bond instead of money capital, either compulsorily or by exercising this power by the holder.

Mandatory convertible bonds into shares:

They are those in which, at the time of their maturation or expiration, both the payment of the capital and the yields represented in such value consists of the delivery of shares, and this decision does not depend on the investor. These values are called BOCEAS.

Bonds optionally convertible into shares:

In these, the delivery of shares as payment of the capital and the yields of the bond at the time of maturity is a decision that only depends on the investor.

In both cases, the law requires that there be shares in reserve necessary by the issuer for the conversion of the bonds.

Risk bonds:

They were created by Law 550 of 1999, they were issued by companies that were subject to corporate restructuring and represented the capitalization of liabilities of said companies. To issue and place the shares and risk bonds, it was only necessary to include them in the subscription regulation agreement, and no procedure or authorization was necessary for the placement of said securities.

Syndicated bonds:

They are those that are issued by several issuers and that are subject to the following conditions:

  1. That a guarantee be signed for all the obligations resulting from the bond, or that the solidarity nature of all the syndicated issuers be foreseen, which implies that each and every one of them can be charged the entire value of the bond.
  2. That there is a written agreement between the syndicated issuers, in which the basic conditions of the issue are defined.
  3. That the administration of the issue be conferred to a single fiduciary entity or to a centralized securities depository.

Bonds issued by multilateral organizations:

In accordance with the law, the issuance of this type of bond must be carried out in a dematerialized form. And in addition to this, as this procedure entails an operation of a non-resident person in Colombia denominated in local currency, which implies transferring resources abroad, it will be an exchange operation, which will not be channeled through the foreign exchange market. compulsorily.

Mortgage bonds:

They are securities with credit content issued by credit establishments, and their exclusive purpose is to fulfill credit contracts to build housing and for its long-term financing.

Those credits that obtain financing through the issuance of mortgage bonds must be guaranteed with first degree or first priority mortgages that do not guarantee any other obligation, in addition to this they cannot be sold, assigned or transferred in any way, nor can they be submitted to any lien or used as collateral by the issuer of the respective bonds.

How to buy bonds?

You can buy bonds in the primary and secondary markets.

Primary market:

Refers to bonuses that have not been previously traded and are offered through:

Private offer : It is addressed to less than 100 specific persons or to less than 500 shareholders of the issuer.

Public offer : When the offer is addressed to unspecified persons or to 100 or more specified persons, and its purpose is the subscription, acquisition of securities issued in series or in mass.

To acquire bonds in the primary market you can do it through two mechanisms:

Underwriting offer : is when private debt bonds or non-national public debt are subscribed through a placement agent or securities broker. This is responsible for making the offer.

Dutch auction : Through this mechanism, the issuer carries out the placement of the issue through an auction, where it defines a cut-off rate and allocates, totally or partially, all offers whose rate is less than or equal to.

Secondary market:

The secondary market refers to the Stock Market. You can acquire them through the electronic platforms managed by the Colombian Stock Exchange and the Banco de la República, respectively.

Also through the counter market called Over the counter (OTC), it refers to the purchase and sale of bonds outside the electronic systems where less liquid bonds are generally traded.

If, on the other hand, you are interested in investing in American Treasury bills or in the German Bund, you should go to international brokers that offer bonds.

There are very few that offer this product for retail investors. We have been able to find

  • Interactive Brokers
  • TradeStationGlobal

Other ways is to add these products indirectly by investing in ETFs or investment funds specialized in bonds.