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Simply put, a bond is a debt instrument. The issuer needs to pay interest to the bond holder at a pre-set rate on a regular basis and repay the invested principal on a specific date.
 

In other words, when an investor purchases a bond, he is effectively lending money to the issuer, which is typically a government, a private company, a supranational organisation or another type of agency. The issuer must promise, in the terms of the issuance, that it will pay interest at the pre-determined rate (i.e. coupon rate) during the lifespan of the bond, and repay the face value of the bond, which means the sum originally invested, on maturity.

The term of a bond, defined at the time of issuance, is referred to as tenor or maturity. In general, the longer the maturity, the higher the coupon rate will be. Short-dated bonds usually have a maturity of up to two years, while for medium-term bonds it is 2 to 10 years; bonds with maturity longer than 10 years are defined as long-term bonds.

Types of Bonds

By issuers

When necessary, governments or corporations issue bonds to raise funds for development projects. As such, bonds can be classified into government bonds and corporate bonds, i.e. in terms of the respective issuers.

Government bonds are issued by national or regional governments and are usually denominated in local currencies. They are considered relatively safe investments with minimum default risk as governments have the ability to redeem the bonds on maturity, since they can even raise taxes or print money, if necessary.

Corporate bonds are those issued by companies to finance their business expansion or new projects. They carry higher risks than government bonds and thus often pay higher interest to investors.

By credit quality

Credit ratings assigned by independent rating agencies, such as Standard & Poor's (S&P) or Moody's, reflect the creditworthiness and default risk of a company.

Ratings from AAA to BBB by S&P are considered investment grade and ratings lower are considered non-investment grade. A company with a stronger balance sheet is typically given higher rating since it has a lower chance of default, whereas those in weaker shape financially are rated lower because of the relatively higher risk of default.

When investing in bonds, investors also take the risk premium into consideration. To appeal to potential buyers, non-investment grade bonds tend to offer higher yields compared to investment grade bonds and hence they are also called high yield bonds.

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