- What is a Bond?
A bond is a long-term debt investment in which an investor temporarily lends money to a bond issuer. Typically, the bond issuer is a corporate or government who agrees to pay interest on a regular basis to the investors.
Who uses Bond?
Bond is used by an entity to raise money and by people who are looking for a stable investment. Owners of bonds are usually debtholders or creditors of the issuer.
- Types of Bonds
- Treasury bonds: issued by the government to fund its budget deficits.
- Other government bonds: issued by federal agencies
- Investment-grade corporate bonds: issued by companies with relatively strong balance sheets
- High-yield corporate bonds (junk bonds): issued by companies with relatively weak balance sheets
- Foreign bonds: bonds denominated by foreign currencies
- Mortgage-backed bonds: their value drops when the rate of mortgage prepayments rises
- Municipal bonds: issued by states or local governments
- How do Bonds work?
When a company need to raise money to finance planned projects or to sustain current operations, they may issue bonds instead of getting loans from a bank. The issuer issues a bond that lawfully states the interest rate that will be paid and the time the initial bond must be returned.
- Secured vs Unsecured Bonds
Secured bond is type of bond that is backed by a specific asset as a collateral. If the bond issuer cannot pay the interest owed or repay the debt, the secured bondholders are able to collect the collateral at least a portion of what they are owed. Meanwhile, unsecured bond is not backed by anything but the full faith and credit of the issuing institution. If bankruptcy occurs, there is no specific asset that can be sold to repay the bondholders.
Why is it safer compared to stocks?
Bonds are safer compared to stocks because they are less risky and have fixed rate of interest. When investors buy a bond, they loan their money for a specific amount of time and will get their initial investment back once the bond matures. When a company issues stocks to investors, the company does not promise to repay the stockholders’ initial investment back.
- Characteristic of Bonds:
- Face valueis the money amount the bond will be worth on the day the bond matures.
- Coupon rateis the rate of interest the bond issuer will pay to the bondholder on the face value of the bond. The coupon rate is expressed as a percentage.
- Coupon datesare the dates on which the bond issuer will pay the interest to the bondholder.
- Maturity dateis the date on which the issuer will pay the bondholder the face value of the bond.
- Issue priceis the price at which the bond issuer sells the bonds when they are first issued.