What Is A Bond?

To put it simply it’s a loan where you lend money to the US government, municipality, a state, or a big company. They use this money to operate all of their functions, pay off debt, etc. This loan has to be repaid to the lender at a predetermined interest rate, and time which is called “maturity”.

The interest rate that the bond will gain is determined by the stability of the company. A good rule of thumb when trying to find out if a company is more stable then the other is the higher the interest rate, the riskier the bond and less stable the company. Of course the more you risk the more potential capital you can make.

One might ask what is the difference between a stock and a bond? With a stock there are no guarantees or promises about dividends or returns. When a company issues a bond the company guarantees to pay back your principle plus interest. When you purchase a bond the price you buy it at or principle is know as its “face value”.

Once you purchase a bond the lender has to hold it to the maturity date, you know exactly how much you are going to get back. For example if you purchase a bond a $2,000 face value, at a ten percent interest rate, and a ten year maturity, you would then collect interest totaling $200 in each of those ten years. When your maturity was up you would then get back your $2000 investment. That is why bond are often referred to as fixed income investments.

Bonds also have another advantage, in some cases they are tax deductible. According to Joshua Kennon, from Your Guide to Investing for Beginners, he says “When a government or Municipality issues various types of bonds to raise money to build bridges, roads, etc. the interest that is earned is tax exempted. This can be especially advantageous with those whom are retired or want to minimize their total tax liability.”

I will now explain corporate bonds because they come in many different varieties. One aspect of corporate bonds has a feature called, a call provision. This allows the company to pay back the face value to the bond holders before maturity. Another aspect of a corporate bond is called convertibles.

They have the ability to convert into shares of common stock. The most common of corporate bonds are called fixed rate bonds. This is where the interest rate paid will never change. Other corporate bonds use floating rates which means the interest rate paid actually changes depending on money markets, treasury bills, etc. These types of rates typically yields lower than those of a fixed rate.

Some corporate bonds are called zero coupons. They make no regular interest payments at all. A zero coupon bond sales at a discount to face value and then is redeemed at maturity for full face value. But regardless of the interest payments and the way that they are structured you invest into the company on one factor only that the bonds are a good investment and you must have faith that the company will repay you.