Bonds are promissory notes issued by a borrower to a lender in exchange for money.
Each bond has a set maturity. Upon maturity, the borrower, or issuer, will repay the loan in full. Bonds also have a predetermined interest rate.
This is the amount of annual interest that you can expect to earn on the face value of the bond between the time you purchase your bond and the time it matures.
Bonds fluctuate in value. You can buy a bond at face value, or par.
You can pay above or below par.
This will affect your yield as the amount of interest a bond pays won’t change.
Bonds bought below par will yield higher than the stated interest rate (the bond’s coupon). Bonds bought above par will have a lower yield than the coupon.
Bonds are rated according to the rating agency’s perception of the issuer to make timely payments of interest and principal to the lender.
Issuers with higher credit ratings will pay less interest to investors than issuers with lower credit ratings.
When bonds are sold by an issuer to investors those with longer maturities can be expected to pay an interest rate that is higher than those that mature sooner.
Who Issues Bonds?
Bonds are sold by many different types of organizations. They include:
- The U.S. Government
- Foreign Governments
- State and Local Governments
- Government Sponsored Entities
- Corporations
Risk Factors
Although the various types of bonds are generally considered more conservative than equities they are not without investment risk. Investment risks should be weighed carefully and understood before you invest in bonds. Some of the major risk factors are:
- Interest rate changes will affect the value of a bond
- Changes that weaken the financial strength of the issuer will affect the value of the bond negatively
- Rating agency upgrades and downgrades
- Changes in the business environment that affect the issuer
- Inflation reduces your purchasing power and makes the value of the income stream generated by a bond less valuable
