A bond is a financial instrument that represents a loan made by an investor to a borrower (typically a corporation, municipality, or government). Bonds are commonly used by entities to raise money for projects, operations, or to refinance debt.
When you buy a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the bond’s face value (principal) when it matures.
Key Features of a Bond
Face Value (Principal): The amount of money the bondholder will receive upon maturity (e.g., $1,000).
Coupon Rate: The interest rate the issuer pays the bondholder, typically expressed annually (e.g., 5%).
Maturity Date: The date when the bond issuer repays the principal to the bondholder.
Issuer: The entity issuing the bond, such as a government, corporation, or municipality.
Yield: The return an investor can expect to earn on the bond, influenced by the bond price and coupon payments.
How Bonds Work
Issue: A company or government issues bonds to raise capital.
Purchase: Investors buy bonds, effectively lending money to the issuer.
Interest Payments: The issuer pays periodic interest (coupon payments) to the bondholders.
Repayment: At maturity, the issuer repays the bond’s face value.
Example
Suppose the U.S. government issues a 10-year Treasury bond with:
Face Value: $1,000
Coupon Rate: 5%
If you buy this bond:
You’ll receive $50 annually as interest (5% of $1,000).
After 10 years, you’ll get back your $1,000 principal.
Types of Bonds
Government Bonds: Issued by national governments (e.g., U.S. Treasury Bonds).
Corporate Bonds: Issued by companies.
Municipal Bonds: Issued by local or state governments.
Convertible Bonds: Can be converted into the issuer’s equity shares.
Advantages of Bonds
Predictable Returns: Steady interest payments.
Lower Risk: Safer than stocks for preserving capital.
Diversification: Helps balance a portfolio.
Disadvantages of Bonds
Lower Returns: Less lucrative than equities in the long run.
Interest Rate Risk: Bond prices fall when interest rates rise.
Inflation Risk: Fixed payments may lose purchasing power over time.
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