What is a Bond?
A Bond is a debt investment in which an investor loans money to a company or government for a defined period of time in return for interest payments.
For Bonds, the lender lends a set amount to the borrower and the borrower will make periodic interest payments to the lender and return the set amount of money, which is called the face value or the par value, to the lender at the end of the term.
How does Investing in Bonds work?
Bonds are issued directly by companies along with a contract that states the coupon rate, the coupon period, the bond’s maturity date and the face value.
The coupon rate is the interests that the bond pays, the coupon period is the number of times interest payments are made, the maturity date is the date when the bond term ends and the face value is the amount paid back at the end of the term.
When you invest in a bond, you can make money either through interest payments or through selling a bond for more than you paid.
- Interest Payments:
When you hold a bond, you will either receive regular fixed or variable interest payments. At the bond’s maturity date, you will get back the face value.
- Selling a bond for more than you paid:
Bond prices and interest rate have an inverse relationship. When interest rate decrease, bond prices will increase. Therefore, if interest rate were to decrease, money could be made by selling your bond on secondary markets before it matures. You will also still receive the interest you’ve made from the bond up until the time you sell it.
Advantages of Bonds
1. Higher Priority to Receive Compensations
In cases where the company is no longer able to pay the promised payments and its assets are to be liquidated, bond owners will be the first to receive compensation for their loss before stock holders.
2. Lesser Risk Compared to Stocks
Bonds are considered to be less risky than stocks due to the bond’s regular pre-scheduled interest payments and also because holders of bonds are guaranteed the face value at the bond’s maturity date.