Obligations, Bonds - Breakdown By GoMining Glossary

Bonds are a kind of IOU. When you buy a bond, you are lending money to a government, company, or region. In return, you receive interest payments for as long as you hold the bond.

Simply put, you are the lender, and the issuer (the entity that issued the bond) is the borrower. However, everything is formalized and legal.

4 main types of bonds and obligations 

1. Government bonds. These securities are issued by national governments and are considered the most reliable. For example, these include US Treasury bonds, UK gilts, and German federal bonds.

2. Municipal bonds. These are issued by regional and local authorities to raise funds for socially significant projects, such as the construction of infrastructure, schools, hospitals, or roads.

3. Corporate bonds. Issued by private or public companies to raise capital for business development, debt coverage, or financing new areas of activity.

4. Savings bonds. These are usually small-denomination government securities created for private investors who want to invest in a reliable and affordable fixed-income instrument.

How bonds affect cryptocurrency markets

1. Investment alternative:

During times of economic stability, some investors prefer to transfer capital from cryptocurrencies to bonds. This is because bonds are considered a safer and more predictable instrument.

As a result, there may be a decline in activity on crypto markets and a temporary outflow of liquidity.

However, when interest rates are low or the economy is unstable, the situation often changes. In search of higher returns, investors begin to pay attention to cryptocurrencies again, considering them a potentially profitable, albeit riskier, asset.

2. Hedging and risk diversification:

Many market participants use bonds as a tool to protect their investments in cryptocurrencies. Thanks to stable coupon payments, bonds help balance the overall risk of a portfolio and offset potential losses from the volatility of digital assets. This approach allows investors to combine traditional and innovative instruments, creating a more sustainable investment strategy.

3. Regulatory influence:

The bond market operates under clearly established rules and is regulated by government institutions. At the same time, the cryptocurrency sector is still in the process of forming a regulatory framework.

Central bank decisions regarding changes in interest rates or government bond issuance policies can indirectly influence investor interest in cryptocurrencies. When bond yields rise, some capital flows out of digital assets, and vice versa — lower rates often lead to increased interest in the crypto market.

How bonds work

Issuance and pricing:

When issuing bonds, the issuer determines their basic parameters — nominal value, interest rate, and maturity date. The nominal value is the amount that the investor will receive back at the end of the term, and the coupon rate indicates the interest income that will be paid to the holder in addition to this amount.

After issuance, the securities are placed on the primary market, where investors purchase them directly from the issuer — the state, municipality, or company. The bonds then move to the secondary market, where they can be freely sold and purchased between participants.

On the secondary market, the price of a bond is no longer fixed and changes under the influence of market factors: interest rates, the general economic situation, and the reliability of the issuer. It is the secondary market that provides liquidity, allowing investors to sell a bond before its maturity date if necessary.

Interest payments

Investors who own bonds receive interest income on a regular basis, usually once or twice a year. The amount of the payments is calculated as a fixed percentage of the nominal value of the security.

For example, if a bond has a face value of $1,000 and a coupon rate of 5 percent, the annual income on it will be $50.

A good example is US Treasury bonds with a maturity of 10 years and a coupon rate of 2 percent — the holder of such a bond receives $20 per year on a face value of $1,000.

US Treasury bonds (T-bonds) are debt securities issued by the US Department of the Treasury to finance the national debt.

The role of bonds in financial markets

1. Safe-haven asset:

Bonds, especially those issued by the government, are often seen as a way to protect your money. Compared to stocks and cryptocurrencies, they're less volatile and offer stable, predictable returns. During periods of economic instability, investors often transfer part of their funds into bonds to reduce the impact of market volatility and preserve capital.

2. A means of portfolio diversification:

Including bonds in an investment portfolio helps to spread risk across different asset classes. Stocks can generate high returns, but they come with significant uncertainty. Bonds, on the other hand, serve a stabilizing function, providing a more consistent level of return and reducing the overall risk of the portfolio.

3. Interest rate indicator:

Bond price dynamics are closely linked to changes in interest rates. When rates rise, the market value of bonds usually falls, and when rates fall, it rises. Thanks to this relationship, bonds are often used as an indicator of monetary policy trends and the overall state of financial markets.

The link between bonds and market sentiment

1. Economic signals:

The bond market is often seen as an important indicator of the state of the economy. One of the key tools for analysis is the yield curve—a graph showing the difference in yield between bonds with different maturities.

If the yield on short-term bonds becomes higher than the yield on long-term bonds, such an inversion may indicate a possible slowdown in economic growth or the approach of a recession. Therefore, analysts closely monitor the shape of the yield curve, using it as an early signal of changes in economic cycles.

2. Investor reaction:

The emotions and expectations of market participants are directly reflected in the value of bonds. When investors are confident in the stability of the economy, they are more likely to sell bonds and transfer funds to more profitable assets, such as stocks. This increases the supply of bonds and lowers their market price.

In the opposite situation, when uncertainty or fear of crisis prevails in the market, interest in bonds increases. Investors then seek safety, buy debt securities, and their prices rise, while yields, on the contrary, fall.

In conclusion

Bonds occupy a significant place in the global financial system. They serve as a reliable investment tool, help balance risks, and reflect the overall state of the economy.

Thanks to their stability, bonds enhance the diversification of investment portfolios and influence market sentiment. Understanding how they work and the factors that affect their value allows investors to make more informed decisions and build sustainable strategies with a long-term perspective.

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Cryptocurrency market operates 24/7/365 without interruptions. Before investing, always do your own research and evaluate risks. Nothing from the aforementioned in this article constitutes financial advice or investment recommendation. Content provided «as is», all claims are verified with third-parties and relevant in-house and external experts. Use of this content for AI training purposes is strictly prohibited.