What is a bond?
Also known as 'fixed income' instruments or 'debt securities', bonds are generally thought to carry a lower risk among 'real' financial assets.
A bond is basically a debt instrument issued by governments and companies to raise required financing. The issuer of a bond is effectively a borrower who wants to raise money from investors who are willing to lend them. The issuer is required to pay interest (known as coupon) to the investors throughout the life of the bond and return the money borrowed (principal) upon the maturity of the bond.
The larger the risk associated with the entity borrowing the funds, the larger will be the compensation for the investor in the form of interest/coupon payments.
Types of bonds
These are issued by national governments around the world - in the UK for example these are commonly referred as 'gilts' and are often described as 'risk free'. Their risk-free status reflects the low probability that the UK government would ever default. Generally speaking, these Government bonds can be issued by any country in the world however bonds issued outside the developed world are usually referred to as ‘Emerging Market Debt’ (see below).
Corporate Bonds are debt securities issued by private and public corporations. Companies carry a higher degree of risk than the government and as such, pay higher interest rates. These are generally classified by credit rating agencies as either 'investment grade' or 'high yield/non-investment grade'. The latter are offered by companies with a less certain financial status and will pay higher income.
These are issued by governments or corporations in emerging markets countries like India, Russia, South Africa and Brazil. These tend to be less stable than developed economies and to this respect carry a higher degree of credit risk which in turn provides a higher interest rate.
These are corporate bonds which may be redeemed for a predetermined amount of the company's equity at certain times during its life, usually at the discretion of the bondholder. This is essentially a bond with a stock option hidden inside. Thus, it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock..
Callable bonds are corporate bonds which can be redeemed by the issuer prior to maturity. The main cause of a call is a decline in interest rates. If interest rates in the markets start to decline since a company first issued the bonds, it will likely want to refinance this debt at a lower rate. In this case, the company will call its current bonds and reissue new, lower-interest bonds to save money. Due to this additional risk for the investor, the callable bond is issued with a higher coupon rate than a traditional bond.
Unsecured bonds are those which do not have any other assets that serve as collateral should the company fail. Unsecured bonds naturally carry more risk than secured bonds; consequently, they usually pay higher interest rates than do secured bonds.
Subordinated debt, also known as junior debt, is debt which ranks after other debts if a company falls into liquidation or bankruptcy. Therefore, subordinated debt holders won't be paid out until after senior debt holders are paid in full.
A zero-coupon bond is a debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full-face value. Because they offer the entire payment at maturity, zero-coupon bonds tend to fluctuate in price much more than coupon bonds. These are generally issued to avoid imposing an ongoing drain on cash flow in the form of ongoing interest payments. These can be issued by both governments and corporations.