Bonds are issued to finance businesses, and their prices are determined by a variety of factors, including the issuer, interest rate, maturity, and insolvency risk. Investors use these factors to evaluate the current value and price of bonds, and formulate investment strategies based on the economic environment and market conditions.
Bonds are securities issued to finance a business. There are different types of bonds depending on the issuing entity, such as government bonds or corporate bonds. The face amount, coupon rate, and maturity date of a bond are determined at the time of issuance. The bond owner receives periodic interest payments after purchase and a final payment of interest and the face amount on the maturity date. The interest is the coupon rate multiplied by the face amount, usually paid annually.
Bonds can also trade before their maturity date, where the price of the bond is determined by several factors, including its present value, maturity, and risk of insolvency. In particular, changes in market interest rates have a significant impact on bond prices: as interest rates rise, the present value of a bond decreases, and the price of the bond decreases accordingly. Because of this volatility, bond investors need to pay close attention to market conditions.
Bond investors weigh the amount of interest they will receive periodically against the size of their net return, which is the present value of the bond minus the purchase price of the bond, which is the sum of the current values of the coupon and face amount, respectively. The present value of the amount of money you will receive in the future from holding a bond takes into account interest rates. For example, if the interest rate is 10% per annum and the amount to be paid next year is 110 won, the present value of 110 won is 100 won. In other words, interest rates affect the present value in the opposite direction.
Therefore, if interest rates rise, the present value of the bond will decrease, which will result in a decrease in the price of the bond. This fluctuating market interest rate is a factor that affects the fluctuation of the bond price due to the present value valuation structure.
The duration of the bond, the period from the time of purchase to the maturity date, also affects the price of the bond. In general, all else being equal, bonds with longer maturities are more sensitive to changes in interest rates and therefore have a greater risk of price fluctuations. While longer maturities offer investors the potential for greater returns, they also come with greater risk, so investors should decide carefully. Since bonds have shorter and shorter maturities after they are issued, the bond price becomes less sensitive to interest rate changes as the maturity date approaches.
Therefore, investors expect higher net returns from bonds with longer maturities, so they prefer bonds with higher face interest rates. This can be an attractive option for investors seeking stable returns over the long term.
The risk of insolvency, the inability to pay the face amount and interest on the promised date, also affects bond prices. For example, if the business environment of the issuer of the bond deteriorates, the company may become insolvent. People who invest in these bonds will demand compensation for the risk they are taking, which will result in a relatively low price for the bond.
On the other hand, because bonds are one of the most fungible financial assets, their price is also affected by the state of other asset markets. For example, if the stock market is booming and returns from investing in stocks are higher, there is less demand for bonds, which can cause bond prices to fall. For this reason, bonds and stocks are often seen as opposing investment choices, and investors build their asset portfolios based on their level of risk tolerance and expected returns.
Due to the complexity of these factors, investing in bonds requires careful analysis and judgment. Understanding the basic concepts and features of bonds and considering the economic environment and market conditions as a whole is essential for successful investing.
