Bonds

A bond is a debt security, similar to an IOU, issued by an entity (usually a government or corporation) in order to raise capital. When you buy a bond, you are lending money to the issuer in exchange for periodic interest payments (known as the coupon) and the return of the bond's face value when it matures.

Key Features:

• Issuer: The entity that issues the bond (e.g., government, corporation).

• Face Value (Par Value): The amount paid back to the bondholder at maturity.

• Coupon Rate: The interest rate paid by the issuer, typically fixed and expressed as a percentage of the bond’s face value.

• Maturity Date: The date on which the bond’s principal is repaid.

• Yield: The return on the bond based on the current market price, which may differ from the coupon rate.

• Credit Rating: A score given by rating agencies that reflects the issuer's ability to repay the debt (e.g., AAA, BBB).

• Types of Bonds: There are various types of bonds, including government bonds, municipal bonds, corporate bonds, and high-yield bonds.

Importance of Bonds:

• Income Generation: Bonds offer predictable income streams through regular interest payments.

• Diversification: Adding bonds to a portfolio can reduce overall risk because they are often less volatile than stocks.

• Capital Preservation: Many investors use bonds as a safer investment option to preserve capital, particularly government bonds.

• Inflation Hedge: Certain bonds, like Treasury Inflation-Protected Securities (TIPS), protect against inflation.

Top 10 FAQs:

What is the difference between a bond and a stock?
A bond is a loan to a company or government, while a stock represents ownership in a company.

How does a bond work?
When you buy a bond, you’re lending money to the issuer for a fixed period, during which they pay you interest. At maturity, they repay the principal.

What is a coupon payment?
A coupon is the interest payment made to the bondholder, typically on an annual or semi-annual basis.

What happens when a bond matures?
When a bond matures, the issuer repays the principal (the face value) to the bondholder.

Why do bonds have ratings?
Ratings assess the creditworthiness of the issuer and the likelihood of repaying the bond.

What are government bonds?
Bonds issued by national governments, often considered low-risk, especially those issued by financially stable countries.

What is the difference between investment-grade and junk bonds?
Investment-grade bonds have higher credit ratings, making them safer, while junk bonds are high-risk but offer higher yields.

Can I sell bonds before maturity?
Yes, bonds can be sold in the secondary market before they mature, though the price may fluctuate based on interest rates and credit conditions.

What is the yield to maturity (YTM)?
YTM is the total return an investor can expect if the bond is held until it matures, including both interest and capital gain or loss.

What factors affect bond prices?
Bond prices are affected by interest rates, credit ratings, inflation, and the issuer’s financial health.

Example:

Imagine you buy a $1,000 bond with a 5% annual coupon rate and a 10-year maturity. You will receive $50 annually as interest (5% of $1,000), and at the end of 10 years, you’ll get back your original $1,000 principal.