2020/08/10

The difference between Coupon Bond & Discount Bond / Investment-grade Bond & Speculative-grade Bond

Bonds are loans issued by the government, public organizations, and corporations to borrow relatively large amounts of cash from people. The most common types of bonds include treasury bonds, municipal bonds and corporate bonds.

The difference from stocks is that bond has maturity and interest, like bank deposits and savings. Stocks pay dividends to shareholders instead of interest, and there is no specific maturity date. Bonds are typically put importance on how it is safe and never be in a risky of bankruptcy rather than the fundamental of growth.

Bonds can be divided into two categories depending on the way interest is paid.
Coupon bond: A bond that pays interest every specific period. Depending on the bond, interest may be paid every three months, annually, or monthly.

Discount Bond: Unlike coupon bonds, discount bonds do not have interest(yield). Another word for discount bond is zero-coupon bond. Discount bonds are literally 'discounted' when issued and promise to buy them back at a higher price later. If issuer buys back later as promised, bond-holders will be able to profit from discount bond.

For example, if the purchaser promises to buy a discount bond issued at 9 million USD for 10 million USD after 3 years, the 3-year yield total will be 11.11% and the 1-year yield will be around 3.7%. From the issuer's point of view, they tend to issue discount bonds because they are burdensome to pay interest on a regular basis.
Discount bonds are a bit burdensome for purchasers who buy bonds. They will have to wait until the expiration. These days, it is said to issue coupon bonds to attract investors.

Bonds can be divided into 4 categories depending on where they are issued. There are treasuries (bill, note, bond, TIPS - government bonds) issued by the government, municipal bonds issued by local governments, bank bonds issued by financial institutions such as banks, and corporate bonds issued by companies such as corporations.

Moreover, there are two types of grades of the bonds.
Investment-grade: These bonds have a higher credit rating, implying less credit risk, than high-yield corporate bonds. (Over BBB- ratings)
Speculative-grade (High-yield): These bonds have a lower credit rating, implying higher credit risk, than investment-grade bonds and, therefore, offer higher interest rates in return for the increased risk. (Under BBB- ratings)
Mostly, companies with low credit ratings issue bonds, interest rates are high. There's a risk of failing to pay back as much as the credit rating is low, so it raises interest rates even more.
Source: Investor.gov
https://www.investor.gov/introduction-investing/investing-basics/investment-products/bonds-or-fixed-income-products/bonds#:~:text=Corporate%20bonds%20are%20debt%20securities,than%20high%2Dyield%20corporate%20bonds.




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