A bond is an agreement between an issuer, usually a corporation or a government, and a holder, usually a commercial institution, individual, or another government. The holder of the bond will expect to receive a fixed interest (the coupon) return for loaning the money and also expect to receive the principle (total sum loaned) back after the bond matures.
A bond is a generic word for a debt agreement or IOU, but the actual names depend on the lifetime of the agreement.
- Bills: have shorter-term maturity dates usually between one and five years
- Notes: medium-term loans between six to twelve years
- Bonds: longer-term loans of more than twelve years
So now you know that a US Government T-Bill is a treasury bill that is issued by the US government for five years or less.
The coupon or the interest earned by the holder of the debt varies depending on the credit quality of the institution issuing the bond.
For example, if the German government issue bonds (bunts), they expect to only have to pay a few percentage points to the holder of the bond because they have a very good credit rating.
However, Spain, when issuing bonds to cover their financial and tax revenue shortfall is considered riskier, therefore, has to pay a higher amount of interest, up to 5% or 6%.
This is why debtor nations like the US, UK, and other European countries must ensure their economies stay in good shape, as the cost of borrowing could suddenly increase due to perceived risk, and this could plunge a country into repayment problems. This is why in 2020, we see serious issues in Europe with the PIGS (Portugal, Italy, Greece, and Spain).
This completes the section on cash-based trading. You can take advantage of fluctuations in currencies to seek a profit. Due to leverage, this can be risky. We also looked at one of the safest investment tools, which are bonds.