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23 May 2023 09h20
Source: Banco Carregosa

Bonds: everything you need to know about investing in bonds

Bonds: everything you need to know about investing in bonds


Find out what bonds are, the benefits and risks of investing in them, and what precautions to take


Put it simply, investing in bonds is the same as lending money to an entity, which can be a company, an institution or even the government itself. That's why investors often use them to diversify and stabilise their investment portfolios. Find out more about bonds, their benefits and risks, and how to invest in them.



What are bonds?


Bonds are a financial instrument by which an investor lends money to a specific entity – corporate or government. Unlike shares, the investor never owns any part of the entity. When an investor buys a bond, they receive a regular income, known as a coupon, and at maturity the face value of the loan is returned to the investor. In other words, instead of going to banks, entities borrow money from investors in order to finance themselves. 


Bond coupon rates may be fixed or variable and are determined at the time of issue. The variable rate coupon is linked to an index, which is usually Euribor for euro issues. 



Bond coupon?


Bonds pay their holders in the form of coupon payments, which may take one of the following forms:


• Zero coupon: the bond is purchased at a discounted price and the investor receives a higher face value at maturity;


• Fixed rate: the coupon is fixed when the bond is issued and is maintained until maturity;


• Variable rate: the coupon is linked to an index, usually Euribor, which can be changed quarterly, half-yearly or annually;


Coupons are calculated daily and normally paid in one of the following 3 periods: quarterly, semi-annually and annually.



What types of bonds are there?

1. Senior bonds


Senior bonds are debt securities with a guarantee of priority for repayment to the investor in the event of bankruptcy. They carry a lower risk premium than other bonds.


2. Subordinated bonds 


Subordinated bonds are redeemed last if the company goes bankrupt. These bonds take precedence over the shareholders and have a higher risk premium than senior bonds.


3. Convertible bonds


Convertible bonds may be senior or subordinated. They give the right to be converted into shares of the issuing company. The terms and conditions are set when the bonds are issued. 


4. Perpetual bonds


Perpetual bonds can be senior or subordinated. They usually have a call date, which is the date on which they can be redeemed. If they are not redeemed, the coupon may vary according to the terms and conditions of the bond issue. The issuers of this type of bond are usually companies in both the non-financial and financial sectors, the most well-known of the latter being CoCos, a type of subordinated debt that is last in line for repayment in the event of bankruptcy, and therefore have carries high risk premiums. 



What are the benefits and risks of investing in bonds?


Bonds are suitable for investors looking for diversification and stability in their portfolio. This is because when you buy a bond, you are buying the right to receive a regular income, the value of which you know in advance. Bond price movements are linked to interest rate levels and the issuer’s risk, which varies over the life of the bond. As this is not static and changes over time, it is important to understand that the investor will always receive the coupon on the face value of the investment.


If the price of the bond goes up, the investor can take advantage of the movement and sell the bond at a higher price and receive the coupon for the number of days they have held the investment. Similarly, if the price of the bond falls, the investor can buy the bond at a lower price.


The main risk of investing in bonds is the issuer’s economic and financial situation. There is a risk that the issuer may go bankrupt and that it may or may not be able to pay the agreed interest or to repay the money lent by the investors. However, there are tools to help assess this type of risk, such as the credit rating or rating of each bond. The rating process is demanding, and assesses various administrative and financial parameters to measure an issuer's ability to meet a debt payment.


Another risk of investing in bonds is the interest rate, which, as it changes, directly affects the risk premium of each issuer, causing the price to fluctuate. However, when the bond matures, you will be paid back at the face value of the bond.


This is why government bonds are such a popular investment for many Portuguese. After all, a country is much less likely to go bankrupt than a company. However, the safer the investment, the lower the interest rate offered. 


As a result, investing in bonds can provide greater predictability, transparency and diversity. 


What precautions do you need to take when investing in bonds?


Before deciding to purchase bonds, review the terms and conditions to ensure that they match your risk profile and financial objectives as closely as possible. It is important to understand the loan terms, the maturity of the bonds, the frequency of interest payments (if applicable) and any associated fees. 


It is also essential that you have a good knowledge of the issuer in order to minimise the risk of lending money to a financially unstable company. You should always the advice of experts who can help you understand the transaction better, in order to protect and make the most of your investment. 



How do I invest in bonds?


The most common, easy and direct way to invest in bonds is through a bank. At Banco Carregosa, you have access to government and corporate bonds. Those issued through a public offer can be acquired by the investor through the subscription forms. You will also be assisted by our experts to optimise the different options according to your current portfolio and your expected returns. It is also possible to invest in bonds through Investment Funds or Asset Management.


Investing in bonds with Banco Carregosa


If you are considering a bond investment, you need to be well informed about the characteristics and rules of this type of investment to understand whether it suits your profile. Purchasing bonds is less intuitive than purchasing shares because it is a complex type of investment. It involves a rigorous and prudent analysis of the buying and selling prices, the interest rates involved and the credit rating of a particular company or country, among other variables. You can rely on the professional and experienced management of Banco Carregosa's experts to select and manage the risks for you.