The Complete Guide to Bonds

What is a bond? In financial terms, a bond is a debt security that people can buy (investors) from companies. In return, investors get to receive rate of returns with interest later on in the future. In simple explanation, you are actually lending a substantial amount of money to a company when you invest in a bond. When a bond is official, it has a specified date at which the company promises to pay you back the amount you have invested. Of course, not only this amount comes with the principal amount (actual amount of money you have invested) but also with interest rates. This is also known as coupon.

How much can you expect to earn from a bond? It depends largely on the specific rate. Some are rated at 6 percent, some at 5 percent. The number of percentage means the rate of return per year you are investing in the bond. For example, if you invest $100,000 annually, you should be able to get a total of $106,000 if your rate is 6 percent. Of course, this is only for one year. The rest of the amount will be compounded annually as accordingly to the number of years you invest. Usually, the number of years is many, amounting up to 5 to 10 years, as in the case for bonds.

On the down side, value of bonds can decrease when new bonds are issued. In this case, the new bond yields higher percentage of 8 percent; higher than your current on going bond (rated at 6 percent). It is sensitive to competition. This is because other people are buying the new bonds which give 8 percent rate of return. Note that the interest rates are fixed for this type of bond.

Other bonds have interest rates that changes all the time. This is especially true with bonds that are adjustable-rate mortgages. Again, you are lending your money to a mortgage borrower. This means you are playing a banker giving someone else the opportunity to borrow a house loan from you. You pay for his house first. He repay s the house loan (your money in the bond) dutifully for the next few years.

There are a few major differences when it comes to bonds. These include the following:

They depend on the body or organizations

If it is a municipal bond, you will be investing your money (or lending) to the state or local government or agency; with Treasuries, federal government; with ‘GNMAs’ (‘Ginnie Maes’), mortgage holder; with corporate bonds, you lend your money to a company.

Quality of the credit for a borrower

When you are investing in a bond, you are lending someone your money. He will then pay you back in, usually in the form of loans. Therefore, your earnings and rate of returns will be affected by whether the borrower will be paying you back as promised or not.

Bond maturity length

There are 5-year, 10-year, 20-year, 30-year and anything in between. Bonds which are stretched over the longer period (for example, 30 years) tend to give the highest return but will also fluctuate more with changes in interest rates.

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