Bonds

How do bonds work?

A bond is a fixed-income security that acts as a loan between an investor and a borrower. Bonds are interest-bearing or discounted government or corporation issued securities where a specified amount is borrowed and then repaid at maturity.

Borrowers are typically companies or governments looking to raise money from investors in exchange for agreeing to pay back the loan in a specific time period at a predetermined or variable interest rate. Bonds are fixed-income securities because they provide payment to the lender, with interest, for the duration of the bond.

Bonds have a maturity date when the borrower must repay the lender the principal amount in full; if they do not, the bond will default and the lender will no longer receive payments. This is why less creditworthy, riskier bonds typically yield a higher interest rate, because the lender is being compensated for their level of risk. The terms of the bond, such as maturity date and coupon rate, are stated in the bond indenture and represent a formal agreement between the lender and borrower.

Can bonds lose money?

Yes, bonds can lose money. Bonds have a maturity date when the borrower must repay the lender the principal amount in full; if they do not, the bond will default and the lender will no longer receive payments. This is why less creditworthy, riskier bonds typically yield a higher interest rate because the lender is being compensated for their level of risk.

If the bond defaults and the principal is not repaid, the investor will lose the amount they originally paid to purchase the bond. The terms of the bond, such as maturity date and coupon rate, are stated in the bond indenture and represent a formal agreement between the lender and borrower.

A bond’s market value can rise and fall based on many factors between issuance and maturity, such as interest rate fluctuations and perceived creditworthiness.

Are bonds a good investment?

Bonds provide fixed income to the investor. Bonds have a maturity date when the borrower must repay the lender the principal amount in full; if they do not, the bond will default and the lender will no longer receive payments. This is why less creditworthy, riskier bonds typically yield a higher interest rate, because the lender is being compensated for their level of risk.

Investors must consider the pros and cons of investing in bonds vs. other investments, such as stocks, that may produce higher returns, but have more volatility.

What are the five types of bonds?

There are many types of bonds. The most common include government bonds, municipal bonds, corporate bonds, investment-grade bonds, high-yield bonds, convertible bonds, and foreign bonds.

Government bonds are issued by the federal government through the Department of Treasury. Municipal bonds are issued by counties, cities, and states. Corporations issue bonds to raise money. Investment-grade bonds have a higher credit rating than high-yield bonds, but do not offer as high of an interest rate.