What is a
In simple terms, a bond is an agreement between a borrower and a lender, where a borrower finances a project by issuing a bond. Bonds, also known as treasuries or securities, are generally issued by governments. The issuer of a bond, or the ‘borrower’, sets the interest rate which is then paid to the investor. At the maturity of this bond the investor is then paid back their initial investment.
Unlike stocks, there’s no central exchange to buy and sell bonds. The bond market is an ‘over-the-counter’ market, which is much bigger than the stock market! It’s also important to note that, as a trader, you aren’t directly buying or selling the bond, you’re simply speculating about how the bond will appreciate or depreciate in value over time.
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Let’s look at interest rates as an example:
Due to inflation, the government decides to raise interest rates. When this happens the interest rate on the bond increases, meaning that the yield, or amount paid back to the investor, will fall. In turn this causes the bond’s price to decrease, because it’s worth less to the original investor!
If a trader were speculating that there would be an interest rate hike, they would then sell the bond, expecting that the price will fall. In the above example, the trader would have therefore made a profit!