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Learn about bonds and why they are beneficial.
What is a Bond?
Bonds are commonly referred to as fixed income securities. When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing debts, they may issue bonds directly to investors. The initial price of most bonds is typically set at par, usually $100 or $1,000 face value per individual bond. The actual market price of a bond depends on a number of factors: the credit quality of the issuer, the length of time until expiration, and the coupon rate compared to the general interest rate environment at the time. The face value of the bond is what will be paid back to the borrower once the bond matures.
How do you make money?
Coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage. For example, a 5% coupon rate means that bondholders will receive 5% x $1000 face value = $50 every year. Because fixed-rate coupon bonds will pay the same percentage of its face value over time, the market price of the bond will fluctuate as that coupon becomes more or less attractive compared to the prevailing interest rates.
Different types of bonds
There are three main categories of bonds:
Corporate Bonds: they are issued by companies for projects. The companies need money for a project so they issue a bond to borrow money for it and will pay the investor back.
Municipal Bonds: they are issued by states and municipalities. Some municipal bonds offer tax-free income for investors. If a city needs money to build a new hospital they can issue a bond. When you buy one of these bonds you are essentially lending the city money to build the hospital, and knowing they will pay you back. These are considered very safe bonds.
Government Bonds: they are issued by the US government typically the Treasury. Bonds issued by the Treasury with a year or less to maturity are called “Bills”; bonds issued with 1 – 10 years to maturity are called “notes”; and bonds issued with more than 10 years to maturity are called “bonds”.
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