Introduction to Bonds

By: acbuddy
If you are relatively new to investing, you probably have heard of stocks, but know absolutely nothing about bonds. They do not offer the same sex appeal as stocks. Movies such as Wall Street and Boiler Room have gotten many neophyte investors excited about the stock market, and not once are bonds even mentioned in these films. Bonds are somewhat perplexing; the terminology is a little confusing. This article will hopefully help you understand how bonds work and whether or not they sound like an appropriate investment vehicle for you.

Simply put, corporations, governments, and municipalities borrow money by issuing bonds for sale to the general public. Companies sometimes need additional monies to expand their business, while governments need money for infrastructure. And just like any other loan, the bondholders are paid an interest rate on their money. And, generally speaking, at the end of a certain term, the borrower has to pay back the face amount of that loan.

Interest payments are made at a predetermined rate and schedule. The interest rate is usually referred to as a coupon. The date on which the borrower has to pay back the principal is known as the maturity date. If the lender holds the bond until maturity, he or she will get their principal back. So, for example, if you lend a company $10,000 by purchasing a corporate bond, and it pays an 8% coupon and has a maturity date of 10 years from now, that means you will be paid $800 per year for the next 10 years, and then you will get back the entire initial investment on the maturity date.

Bonds are considered debt instruments, whereas stocks are equity. The reason why stocks represent equity, or ownership, in a corporation, is because stockholders are entitled to receive a portion of the earnings in a corporation, whereas bondholders are only entitled to receive interest payments on their loan. If the bond issuer goes bankrupt, bondholders have a higher claim on the assets derived from the liquidation of the company; stockholders are compensated only after everyone else if a company goes belly up, and sometimes get nothing at all.

There are basically 3 different types of bonds. Government bonds are issued by the federal government, and are considered the safest as is the debt of any country with economic stability. Municipal bonds are issued by local governments, and are also considered safe. More importantly, municipals are exempted from federal tax and often from state taxes as well, making them a very lucrative investment. Finally, there are corporate bonds, which can be risky, depending on the financial condition of the company that is doing the issue.

I hope this information has helped you become familiar with bonds. Try to set aside some money for investing and start while you are still young. The earlier you begin, the more money you can potentially make down the road. Carefully research the credit rating of the company when investing in corporate bonds, and go for municipals or government issues if looking for security.
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