3. Knowledge required for investment (Bonds)

Definition of Bond:
A bond is a security issued by governments, financial institutions, or corporations to raise capital through legal procedures. It promises to repay the principal on a specified maturity date and pay periodic interest at an agreed rate.

Key Roles and Markets:
Issuer: The borrower. Bonds are mainly categorized by issuer:
Treasury Bonds: Issued by central governments. Backed by national credit, they are considered the safest with minimal risk.
Municipal Bonds: Issued by local governments for urban projects. Slightly riskier than treasury bonds.
Financial Bonds: Issued by banks or financial institutions.
Corporate Bonds: Issued by companies. Highest risk due to potential default, with interest rates varying by credit rating (e.g., AAA, AA, B). Lower credit = higher risk = higher interest to compensate investors.
Bondholder: The lender, often institutional investors (pension funds, insurers, mutual funds) seeking stable cash flow.
Bond Market: Includes primary (issuance) and secondary (trading) markets. Bonds can be traded before maturity, e.g., if someone needs cash, they can sell the bond to another party.

Analogy:

Imagine your booming bubble tea shop needs ¥100k to expand. To avoid equity dilution (issuing new shares), you opt for debt.
Bond Creation:
You issue standardized "IOUs" (bonds) with:
Face Value: ¥1,000 per bond (100 bonds for ¥100k).
Coupon Rate: 5% annually (¥50/year per bond).
Maturity: 3 years (repay ¥1,000 then).
Issuer: Your tea shop.
Holder: Any buyer (e.g., investor Xiao Zhang).
Relationship: You (debtor) must pay ¥50/year and repay ¥1,000 at maturity, regardless of business performance. Bond = Standardized loan contract.

Why Do Bond Prices Fluctuate?

Key driver: market interest rate changes.
Scenario 1: Rates Rise (e.g., to 7%)
Xiao Zhang’s 5% bond becomes less attractive. To sell, he must lower its price (e.g., ¥960) to match new bonds’ 7% yield.
Result: Bond prices fall when rates rise.
Scenario 2: Rates Fall (e.g., to 3%)
Xiao Zhang’s 5% bond is now premium. He can sell it above face value (e.g., ¥1,040).
Result: Bond prices rise when rates fall.
Core Insight: Bond prices and interest rates move inversely.