Understanding Bonds: How They Work, Profit, and Differ from Stocks

A bond (Hebrew: אג"ח) is essentially a loan that investors give to a company or government in exchange for periodic interest payments, known as coupons, and the return of the principal at maturity. This contrasts with stocks, which represent ownership in a company without any guaranteed return. Bonds are generally considered less risky than stocks and come mainly in two types: government bonds, issued by the state, and corporate bonds, issued by private companies.

When purchasing a bond, the investor becomes a creditor entitled to fixed interest payments and the repayment of the principal, provided the issuer remains financially stable. Stocks, on the other hand, confer partial ownership, exposing investors to both profits and losses without guaranteed returns. The main profit from bonds comes from the coupon payments, which are predetermined at issuance and reflect the issuer’s credit risk, the less reliable the issuer, the higher the interest rate offered.

Bond prices fluctuate inversely with market interest rates: when rates rise, bond prices fall, and vice versa. Investors holding bonds to maturity receive the full principal regardless of price changes. Government bonds in Israel, managed by the Ministry of Finance, are considered the safest investment with lower interest rates due to the low risk of default. Corporate bonds carry varying risk levels depending on the issuing company’s financial health, with higher risk companies paying higher interest.

In the event of bankruptcy, bondholders have priority over shareholders in claims on the company’s remaining assets, increasing their chances of recovering some or all of their investment. However, bonds are not risk-free; if assets are insufficient, bondholders may still incur losses. Another common type in Israel is inflation-linked bonds, where both principal and interest adjust according to the consumer price index, protecting investors from inflation erosion.

In summary, bonds offer a loan-based investment with fixed income and lower risk compared to stocks, but with limited upside potential. Investors should understand the differences between bond types, risks, and how inflation protection works when considering bonds as part of their portfolio.