Bonds are a frequently traded financial instrument, often seen as a safe yet reliable way to diversify your investment portfolio.

Despite their reputation for being complex or offering lower returns, bonds can be a powerful tool to balance risk, reduce volatility, and secure stable returns.

This guide will explore the basics of bonds, types of bonds available for trading, and how you can incorporate them into your investment strategy.

What are bonds?

Bonds function as a form of debt. When companies or governments need to raise funds, they issue bonds to investors, effectively borrowing money. In return, investors (bondholders) receive regular interest payments, known as coupons, until the bond matures. Upon maturity, the principal amount (or face value) is returned to the bondholder.

Though generally seen as lower-risk investments, bonds can be influenced by various factors, including interest rates and credit risks. Different entities issue bonds, and each bond has a specific credit rating that reflects its investment grade.

Types of bonds

Bonds can be classified into secured and unsecured bonds. Secured bonds offer some form of collateral, making them less risky. Unsecured bonds, or debentures, do not come with any backing and thus carry higher risk.

Government bonds

Issued by national governments, these bonds are considered low-risk, especially when issued by stable governments. In the U.S., government bonds are referred to as Treasuries, while in the U.K., they are called gilts. These bonds can have either fixed or variable interest rates.

Corporate bonds

Issued by companies to raise funds, these bonds offer higher returns than government bonds but come with higher risks. Corporate bondholders enjoy certain protections, such as being repaid before shareholders if a company goes bankrupt.

Municipal bonds

Issued by local governments, these bonds are often lower risk, with tax benefits for investors in some countries, like the U.S.

Agency bonds

Mostly found in the U.S., these bonds are issued by government-sponsored entities, such as Fannie Mae and Freddie Mac.

How do bonds work?

Bonds serve as a loan agreement between the bondholder and the issuing entity (government or corporation). In return for lending money, bondholders receive coupon payments at regular intervals, which could be monthly, quarterly, or annually. At the bond’s expiration (maturity), the bondholder receives the original loan amount, known as the principal.

Bonds are negotiable securities, meaning they can be traded in secondary markets. This trading allows investors to sell or buy bonds at varying prices, based on interest rates and other market conditions. Most bond trading occurs through over-the-counter (OTC) markets or using contracts for difference (CFDs).

Key bond characteristics

Several important factors distinguish bonds from other financial assets:

Maturity and duration

Maturity refers to the length of time before the bond expires and the principal is repaid. Duration, however, measures the bond’s sensitivity to interest rate changes. Bonds with longer durations are more susceptible to interest rate fluctuations.

Credit rating

Credit ratings indicate the bond’s risk level. Bonds with the highest rating (AAA) are considered the safest, while bonds below investment grade are known as “junk bonds.”

Face value

The face value (or principal) is the amount repaid to the bondholder upon maturity. Bonds are typically issued at face value, although their market price can fluctuate based on demand and other factors.

Coupon rates

This refers to the interest paid to bondholders, usually calculated annually. Coupon dates are the specific intervals when these payments are made, typically monthly, quarterly, or annually.

What influences bond prices?

Several factors affect bond prices, including:

Supply and demand

Bonds are subject to market demand. High demand pushes bond prices up, while low demand causes prices to fall.

Interest rates

Bond prices and interest rates are inversely related. When interest rates rise, bond prices generally fall, and when rates fall, bond prices increase.

Credit ratings

A bond’s credit rating reflects its risk level, with lower-rated bonds usually offering higher returns but carrying more risk of default.

Maturity

As bonds near maturity, their prices tend to move closer to their face value, regardless of market fluctuations.

How to trade bonds

Once you understand the basics of bonds, you’re ready to learn how to trade them. Here’s a step-by-step guide:

Choose the type of bond

Decide whether you want to trade government bonds or corporate bonds. One popular way to trade bonds is through bond CFDs, which allow you to speculate on the price movements of bonds without owning the underlying asset.

Select a trading strategy

For bond CFDs, there are two main strategies:

Hedging

This involves offsetting potential losses by holding positions in both bonds and other assets.

Interest rate speculation

Traders speculate on future interest rate changes to predict bond price movements.

Open a bond trading account

Once you’ve decided on the type of bond and strategy, open a trading account. VFTradings offers a simple setup for live trading accounts, allowing you to trade in real markets. You can also use a demo account to practice your strategy risk-free.

Place your first trade

With your account set up, you’re ready to make your first trade. VFTradings provides advanced platforms like MetaTrader 4 and MetaTrader 5 to help monitor positions and execute trades efficiently.

For additional guidance or assistance, feel free to reach out to our team at VFTradings.