Bonds are a type of securities and represent the amount that is paid as a loan by the lender to the borrower (individual, company or government institution). The bond among the lender and the borrower is known as an I.O.U (a signed document representing the loan), and the I.O.U contains information about the loan and how and when it will be paid. Bonds are mostly used in states, municipalities, companies and sovereign governments, and the desired projects and operations are financed by these bonds.

As mentioned, bonds include various details that indicate the maturity date, the loaned amount (purchase price of the bond); and determining the interest payment method (which includes two types of fixed and variable) by the bond issuing institution.

It should be noted that bonds are tradable and that is why they are considered a type of securities. The bond holder is paid regular (usually annually) profit or interest at the rate mentioned in it. The price of bonds is inversely correlated with the interest rate, such that when the interest rate of the central bank increases, the price of bonds decreases and vice versa.

Bonds have a maturity date on which the principal of the borrowed amount must be withdrawn; otherwise your money will be at risk.

How Bonds Are Priced                                          

The pricing of bonds is based on their specific characteristics and like other securities in the market; the price is determined by supply and demand. Bond prices change on a daily basis, just like other tradable securities. But in general, there is a specific logic for valuing bonds.

So far, we’ve talked about getting back the principal amount of the loan along with its interest on the due date. But anyway, you don't have to keep these bonds until maturity to get your principal money back, but you can sell your bonds in the open market whenever you want; and the interesting thing is that in these markets the price of bonds fluctuates, sometimes even very dramatically.

Bond prices fluctuate with changes in government interest rates in the economy. For example, if you buy one of the bonds issued by a company worth $1,000 and you are promised a 10% annual interest, you can receive $100 in cash from the bond issuer each year.

Assuming that the interest rate of the central bank is equal to the interest rate of an institution's bonds (at the time of its issuance), i.e. the same 10% annual interest, it does not matter to the investor which one he/she invests in, because both have the same amount of interest. But imagine what will happen if the interest rate of the central bank drops to 5% after a while? It should be said that now the annual interest of bonds will be higher than the annual interest of the central bank. Therefore, the demand for bonds has increased and we assume that the same bonds worth 1,000 dollars are now sold to investors (by the issuing institution) for 2,000 dollars, and people who previously bought their bonds for 1,000 dollars now instead of waiting for the maturity date, they can sell their bonds for $2,000 and get the profit they had to wait for several years now. And also the opposite of this whole thing can happen, that is, the interest rate of the central bank will increase compared to bonds, and the demand for these bonds will decrease and their prices will fall.

Some Advantages and Disadvantages of Bonds:

Advantages: - Bonds pay your interest regularly.

- You can keep your bonds until the maturity date and receive the principal amount in addition to the interest.

- By selling your bonds at a higher price than the purchase price, you can make a profit.

Disadvantages: Bonds usually have lower profit than stocks.

Sometimes the bond issuing institution may go bankrupt and not be able to repay your principal amount.

- Sometimes, with the increase in the price of bonds, its yield (interest rate) may decrease and its owner will suffer losses.