You could say buying bonds is like raising cash, isn’t it? Well, yes. But it’s cash you intend to return. You don’t do that with a share except in the case of a buy-back. And like loans, with a bond there’s a moment in time when you’ll be RETURNING that cash – the bond’s MATURITY date. There’s one exception and that’s irredeemable bonds or perpetuities, but these are extremely rare.

Also like a loan, the issuer pays interest regularly to the bond holder. The level of interest, the coupon, usually indicates the security of the bond – the safer it is, meaning the higher the chance of being able to redeem its cost, the lower the coupon. A high fixed return usually denotes a less secure bond – someone who intends to default on his loans in the most extreme case.

Now bonds can be issued by companies, but the most popular type are government bonds. England was the first country to realize it could fund its wars against France that way; and during World War 2 the US government used major Hollywood stars to sell the public war bonds.

As you’d expect, government bonds are usually more secure. In fact, you’ll probably find that they take up the major portion of most investment funds. Less return, more security to redeem their cash value upon maturity.

And now, it’s time to make things complicated. Because, both the bond’s price and its return have two sets of definitions. Let’s start with the annual return. As mentioned, that’s referred to as the coupon, and you SHOULDN’T confuse that with the bond’s YIELD. The yield is its rate of return. If we’re talking about CURRENT yield, that’s the interest rate as a percentage of the bond’s original cost. If yield-to-maturity, that’s the TOTAL sum of interest as a percentage of the cost.

And then, there’s the bond’s original price. While with stocks there’s no difference between what you pay for a share and what it’s worth, with bonds, sometimes the original cost will differ from the face value or par value. That’s what the bond will be worth when you sell it upon maturity.

Where the face value equals the original price – what you paid, you’ll be buying it on par. If it’s more, the bond is selling at a discount and if its less – at a premium.

Now, if a central bank, for example, offers a higher interest rate than a bond, that makes the bond a bad investment and lowers its value. If it offers less, vice versa. This will certainly influence the bond’s par value.

Traditionally, when a gradually rising inflation was a sign of economic development, governments gradually raised interest rates in tandem. That created a positively sloping yield to interest ratio curve, since the closer a bond is to maturity as relative yield decreases. When long-term yields fall below short term yields, that’s a sign people have less confidence in an economy. The result is an inverted curve and quite often the forewarning of a recession.

So remember: when trading bond derivatives online, always consult your economic calendar to see a bond’s yield. It’ll tell you if the bond is a wise investment and how optimistic investors are in general.