A bond is a contract between a lender and a borrower, which includes the principal amount, interest rate, term / period, start date, end date, payment details and few other details. It is a type of a Fixed Income Instrument used by Investors and Institutions to park some of their funds for a relatively safer return. The returns on investments in a Bond is relatively lower as compared to the Stock investment. However, it also carries less market risk. Bonds are issued by private institutions, listed companies, government organizations, municipalities, states, and sovereign governments to finance projects and operations. Bonds are rated by independent financial rating agencies, such as Moody’s, S&P, Morningstar etc. These ratings vary from AAA to D, based on the rating agency.
There are a number of types of Bonds issued and used in the financial market. Some of the popular ones are:
In Stocks, investors own a certain number of shares of the company. In Bond, Investors lend money to the company as debt. The advantage of Bonds over Stocks is that, in a situation of bankruptcy of the issuer, bondholders are paid first and stockholders at the very end.
In terms of the price movement, Bonds and Stocks have inverse correlation. Bond value is driven by interest rate, while Stock price is driven by company performance. If the overall economy is not doing good, the chances of Stock price going lower is high. At the same time, a bad economy drives the interest rate down, causing the Bond value to go up (as the interest rate of Bond is already fixed). Hence, generally (and not always) Bond prices go up when Stock prices (in the overall market) go down and vice versa. This is an important correlation to understand, as this feeds into market timing and trading strategies.