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What is Bond?

Definition of Bond

A bond is a debt investment instrument in which an investor loans a specified amount of money to a given entity (for example: governments, municipalities or corporations); this is typically to enable the recipient of the loan to fund a project or activity and must be repaid after an agreed upon period of time at a variable or fixed interest rate. The interest rate that the bond guarantees to be repaid when the bond matures is known as the coupon,but before the bond matures the actual interest rate that is paid on it depends on market trading activity. The changing interest rate on a bond is a function of the nominal price of the bond (always 100) minus the traded price of the bond in the market; or to put it another way, if there is no speculative activity factored in then 100 minus the interest rate on the coupon of the bond equals the price. For example, let us say that a 30 year U.S. Treasury bond (a key benchmark of the international bond market, as the U.S. is always well-rated and the duration is long and consequently less prone in theory to short-term market movements) has a coupon of 10% (it will be referred to as 'the 30 Year 10% US Treasury'), then the price is 90 (100 10% coupon). If the price at the end of a particular day is 88.50, for instance, then the owner of the bond will accrue 11.5% for as long as that price holds (100 88.50 traded price = 11.5% interest rate). So, the more risky the profile of the country issuing the bond, the higher the interest rate that will be required to compensate investors for the incrementally higher risk, and thus the lower the price of the bond. Looking at the risk factor specifically, in the most basic terms, it can be gauged from averaging out the foreign currency-denominated sovereign bond credit ratings of the leading two global ratings agencies Standard & Poor's (S&P), and Moody's. The local currency-denominated bond ratings are irrelevant for investors as, in practice, a country can simply print more of its own currency ('quantitative easing' is effectively the same thing) when required but cannot print more foreign currency to meet its foreign obligations as it cannot simply instruct another country's central bank to do its bidding. The major global exception to the first point here is for the constituent countries of the eurozone, which are dependent on the European Central Bank (ECB) for printing money. This dependence on a non-indigenous central bank, together with the fact that the euro's value does not reflect the inherent state of an individual member's economy in the same way that its former currency could, is cited by many in the markets as being the key problem in the alliance.
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